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Chapter 30Chapter 30Chapter 30Chapter 30Financing Government: Financing Government:
Taxes and DebtTaxes and Debt
04/18/23
©©1999 South-Western College Publishing
2
In what possible three ways do we pay for government
spending?
In what possible three ways do we pay for government
spending?• Taxes• Debt• Inflation (via
printing of money)
©©1999 South-Western College Publishing
3
What does government spending have to do with
Opportunity Costs?
What does government spending have to do with
Opportunity Costs?A dollar spent by the
military on an airplane is a dollar that cannot be spent on a new house
©©1999 South-Western College Publishing
5
Why Pay Taxes?Why Pay Taxes?
• Quote from Oliver Wendell Holmes: “Taxes are the price we pay for civilization”
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Classifying taxes in relation to income
Classifying taxes in relation to income
• Proportional• Progressive• Regressive
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What is a Proportional Income Tax?
What is a Proportional Income Tax?
A tax that is a fixed percentage of income, regardless of the level of income, a flat rate tax
©©1999 South-Western College Publishing
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What is a Progressive Income Tax?
What is a Progressive Income Tax?
A tax whose rate varies directly with the income of the person taxed; rich people pay a higher rate
©©1999 South-Western College Publishing
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What is a Regressive Income Tax?
What is a Regressive Income Tax?
A tax whose impact varies inversely with the income of the person taxed; as a percentage, poor people pay the most
©©1999 South-Western College Publishing
10
Classifying taxes in relation to income
Classifying taxes in relation to income
• Proportional: as income rises, the same % of income is paid in tax (flat tax)
• Progressive: as income rises, a higher % of income is paid in tax (graduated rate)
• Regressive: as income rises, a lower % of income is paid in tax
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10% Proportional tax10% Proportional taxIncome Tax Tax/income$30,000 $3,000 .10 (10%)
$40,000 $4,000 .10 (10%)
$50,000 $5,000 .10 (10%)
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Progressive tax: Hypothetical marginal tax
brackets
Progressive tax: Hypothetical marginal tax
brackets
Income from 0-$20,000 taxed at 10%Income from 20-$40,000 taxed at 20%Income over $40,000 taxed at 30%
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Progressive taxProgressive taxIncome Tax Tax/income$30,000 $4,000 .13 (13%)
$40,000 $6,000 .15 (15%)
$50,000 $9,000 .18 (18%)
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Examples of regressive taxes
Examples of regressive taxes
• Poll taxes• Sales taxes• Social security tax
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What is a Poll Tax?What is a Poll Tax?A tax of a specific absolute
sum levied on every person or every household
©©1999 South-Western College Publishing
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Why are sales and Excise Taxes regressive?
Why are sales and Excise Taxes regressive?
Because low income people spend a larger percentage of their income on purchases than high income people
©©1999 South-Western College Publishing
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Major Federal TaxesMajor Federal Taxes
• Personal income tax• Social security taxes
(payroll tax)• Corporate income tax
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State and local taxesState and local taxes
States: sales and income taxes
Local: property and real estate taxes
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What is a Corporate Income Tax?
What is a Corporate Income Tax?
A tax levied on a corporation’s income before dividends are distributed to stockholders
©©1999 South-Western College Publishing
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For information and statistics concerning taxes:
For information and statistics concerning taxes:
http://www.us.govhttp://www.irs.ustreas.gov/
prod/tax_stats
©©1999 South-Western College Publishing
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How are Income Taxes Progressive in the U.S.?How are Income Taxes Progressive in the U.S.?
Most people are in either the 15% or 28% tax bracket, but some are in the 31%, 36%, or 39.6% bracket
©©1999 South-Western College Publishing
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What are Exemptions and Deductions?
What are Exemptions and Deductions?
They are both subtracted from gross income to determine taxable income
©©1999 South-Western College Publishing
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Visit a few organizations that
advocate tax reform:
Visit a few organizations that
advocate tax reform:http://www.atr.orghttp://www.ctj.org
http://www.cats.org
©©1999 South-Western College Publishing
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Theories of taxationTheories of taxation• Ability to pay: tax in accordance
with ableness to pay--suggests using income and wealth taxes
• Benefits theory: tax those who benefit from the programs that the taxes are used to finance--gas taxes, license fees
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Tax IncidenceTax Incidence
• Who really pays a tax and thus bears its burden?
• Incidence is complicated by tax shifting
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Shifting of taxesShifting of taxes
• Forward: to the consumer
• Backward: to the worker or resource supplier
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What is a Federal Deficit?What is a Federal Deficit?A Deficit occurs when
the government spends more than it receives in tax revenues
©©1999 South-Western College Publishing
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Where does government get the money when
there is a deficit?
Where does government get the money when
there is a deficit?Borrow the money by
selling treasury bonds, notes, etc. known as government securities
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What are the different kinds of securities?
Treasury ...
What are the different kinds of securities?
Treasury ...• Bills• Bonds• Notes
©©1999 South-Western College Publishing
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What is a Treasury Note? What is a Treasury Note? A Treasury bond that
matures in 2 to 10 years and is sold in denominations as low as $1,000
©©1999 South-Western College Publishing
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What is aU.S. Savings Bond?
What is aU.S. Savings Bond?
A nonmarketable Treasury bond that is the most commonly held form of public debt
©©1999 South-Western College Publishing
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What is a Treasury Bond?What is a Treasury Bond?A Treasury Bond takes 30
years to mature and is sold in denominations as low as $1,000
©©1999 South-Western College Publishing
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What is aTreasury Bill?
What is aTreasury Bill?
A bond that matures in 3, 6, or 12 months with minimum denominations of $10,000 and multiples of $5,000 above this
©©1999 South-Western College Publishing
35
What is the Public (national) Debt?
What is the Public (national) Debt?
The total value of government securities held by individuals, businesses, other government agencies, foreigners, and the Federal Reserve
©©1999 South-Western College Publishing
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Budget PhilosophiesBudget Philosophies
1. Annually balanced2. Cyclically balanced3. Functional finance
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Annually balanced budget
Annually balanced budget
Try to set G=T each yearProblem: could be
destabilizing to the economy
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•Start with G=T• Recession hits
•G rises, T falls, deficit (cyclical) arises
•In order to balance budget, either raise T or lower G, but this is contractionary
policy•Could worsen recession
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Cyclically balanced budget
Cyclically balanced budget
Balance the budget over the course of the business cycle, not necessarily each year
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Functional financeFunctional finance
Balance the economy, not the budget: shoot for full employment, stable prices, regardless of the budget
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Cyclical vs structural budget
Cyclical vs structural budget
Structural: what the budget would be with existing tax laws and spending programs, assuming full employment
Cyclical: difference between the actual budget and the structural
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ExampleExample
Say present deficit is 200 billion, unemployment rate is 7%: assume full employment is 5%: at full employment suppose the deficit would only be 50 billion: then 50 billion is the structural deficit, the other 150 billion is the cyclical deficit
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Why is an internally financed public debt not a burden to
future generations?
Why is an internally financed public debt not a burden to
future generations?Because even though
people pay taxes to finance the debt, they also receive interest payments
©©1999 South-Western College Publishing
45
Why is an externally held debt a burden to future generations?
Why is an externally held debt a burden to future generations?
Because people pay taxes to finance the debt without receiving the interest payments
©©1999 South-Western College Publishing
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What are some problems with the National Debt?
What are some problems with the National Debt?
• Not everyone holds the debt• It promotes overconsumption• It can create inflation• It can crowd out private
investment©©1999 South-Western College Publishing
47
For the latest statistics on the Public Debt:
For the latest statistics on the Public Debt:
http://www.publicdebt.treas.gov
©©1999 South-Western College Publishing
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• When the government spends a dollar, do we always pay for that dollar?
• In what possible three ways do we pay for that dollar?
• What does government spending have to do with Opportunity Costs?
• What are alternative ways to levy taxes?
• What is a Social Security Tax?
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• How are Income Taxes Progressive in the U.S.?
• What does it mean that each dollar of income is taxed on the Margin?
• What is a Federal Deficit?• What is the Public Debt?• What are the different kinds of
securities? Treasury …• What are some problems with the
National Debt?