Chapter 14Taxes and Government Spending

Taxes Tax – Financial charges imposed on individuals

and businesses by a government Purposes of taxes

To provide public goods that the market does not provide (e.g., military, roads, libraries)

Income redistribution (e.g., assistance to the poor, social security)

Classifications of Taxes Progressive Taxes – charge the rich a

higher % of income than the poor Example – Income taxes in the U.S.

Classifications of Taxes Proportional Taxes – charge all people an

equal % of income Example – Proposed “Flat Tax”

Classifications of Taxes Regressive Taxes – Charge the poor a

higher % of income than the rich Example – Sales Taxes, FICA Payroll

Tax

Government Spending Fiscal Policy – government policies involving

collecting tax revenue and deciding how to spend it Executive branch submits a proposed budget

to Congress Congress makes revisions and votes on the

final budget President has choice to sign or veto the

budget

Government Spending What is the budget (approx. $2.7 Trillion) currently spent on?

Health – 23% Includes Medicare, Medicaid, Safety Inspections,

Veterans Benefits Social Security – 22% Defense – 21% Income Security – 13%

Includes Unemployment Assistance, Housing Assistance, Food Stamps

Government Spending What is the budget (approx. $2.7 Trillion) currently spent on?

Interest on the Debt – 9% Other Programs – 7%

Includes Homeland Security, Science and Technological Research, Agriculture Subsidies, many more

Education – 3% Environmental Protection – 1% International Affairs – 1%

Includes assistance to foreign countries

Government Spending Possible outcomes of budgets

Surplus – more tax revenue than government spends

Deficit – more spending than tax revenue Money must be borrowed to make up the

difference (government sells bonds) Creates debt – money that has not been

repaid over time, plus interest

Perspectives on Debt and Deficit Deficit Hawks – opposed to deficit spending

Classical economists like Von Hayek and Friedman Believe deficits are unsustainable, pass costs on that

will hurt future economic growth, raise interest rates Deficit Doves – believe deficit spending can stimulate

economic growth Keynesian economists See no harm in short term deficits, as long as they

are used wisely, they could produce future growth that exceeds the present deficit

Expansionary vs. Contractionary Fiscal Policy Just like monetary policy can expand or contract the

economy, so can fiscal policy Expansionary policy – to grow GDP and cut

unemployment, but could cause inflation Cut taxes on individuals Spend more on benefits and other programs

Contractionary policy – to cut inflation, but could lead to slowing growth and raising the unemployment rate

Raise taxes on individuals Cut government spending

Perspectives on the “Best” Fiscal Policy Classical Economists (like Von Hayek, Friedman)

Government should not interfere in the economy, to establish equilibrium prices and quantities

Demand-Side (Keynesian) Economists Government should cut taxes on individuals, spend

money to benefit people in order to raise demand and grow the economy

Supply-Side Economists (Reaganomics) Government should cut taxes and regulations on

businesses to raise supply and grow the economy