#

McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

Public Finance: Expenditures and Taxes

12

12-2LO1

Government and the Circular Flow

(1) Costs

RESOURCEMARKET

PRODUCTMARKET

BUSINESSES HOUSEHOLDS

(4)Goods and services

(7)Expenditures

(8)Resources

(9)Goods and services

(4)Goods and services

(10)Goods and services

Net taxes(12)

Net taxes(11)

(3) Consumption expenditures(3) Revenues

GOVERNMENT

(1) Money income (rents, wages, interest, profits)

(2) Land, labor, capital

Entrepreneurial Ability

(2) Resources

(5) Expenditures (6) Goods and services

12-3LO1

Government Finance

• Government purchases

• Exhaustive

• Transfer payments

• Nonexhaustive

• Borrowing and deficit spending

• Opportunity cost is low during recession, high during growth

12-4

20%

40

35

30

25

20

15

10

5

0 2010

1960

GovernmentPurchases

Governmenttransfer payments

22%

15%5%

Year

Per

cen

tag

e o

f U

.S. o

utp

ut

LO1

Government Finance

Government purchases, transfers, and total spending as percentages of U.S. output

12-5LO1

Global Snapshot

12-6LO1

Federal Expenditures

Pensions & income security

38%

All other12%

National defense

20%

Health24%

Interest on public debt6%

Payroll taxes40%

Excise taxes3%

All other6%

Corporate income tax

9%

Federal expenditures: $3456 billion Federal tax revenues: $2162 billion

12-7LO1

• Personal income tax

• Progressive tax

• Marginal tax rate

• Payroll taxes

• Corporate income tax

• Excise taxes

Federal Tax Revenues

12-8

Federal Tax Revenues

LO1

(1)Total Taxable

Income

(2)Marginal Tax

Rate %

(3)Total Tax

on HighestIncome inBracket

(4) Average Tax Rate

on Highest Income in Bracket

% (3) / (1)

$1–$17,000 10 $ 1700 10

$17,001–$69,000 15 9500 14

$69,001–$139,500 25 27,125 19

$139,501–$212,300 28 47,509 22

$212,301–$379,150 33 103,570 27

Over $379,150 35

Federal Personal Tax Rates, 2011*

* For a married couple filing a joint return

12-9

State and Local Finance

• State revenues

• 48 percent from sales and excise taxes

• 40 percent from personal and corporate taxes

• License fees and other taxes make up the rest

LO1

12-10

State and Local Finance

• State expenditures• 37 percent on education• 28 percent on public welfare• 8 percent on health and hospitals• 7 percent on highway maintenance

and construction• 4 percent on public safety• 20 percent on other purposes

LO1

12-11

State and Local Finances

• Local finances• 71 percent of revenues from property taxes• 17 percent of revenues from sales and

excises taxes• 44 percent of expenditures on education• 12 percent on welfare, health, and

hospitals• 11 percent on public safety• 11 percent on housing, parks, and

sewerage • 6 percent on streets and highways

LO1

12-12

Local, State, and Federal Employment

• State and local jobs• 50 percent in education• 9 percent in hospitals or health care• 10 percent in police and corrections

• Federal jobs• 50 percent in national defense or postal

service• 12 percent in hospitals or health care• 4–7 percent in natural resources, police,

and financial administrationLO1

12-13LO2

Apportioning the Tax Burden

• Size, distribution, and impact of the costs that taxes impose on society

• Benefits-received principle

• Ability-to-pay principle

12-14LO2

Apportioning the Tax Burden

• Progressive tax—average tax rates increase as income increases

• Regressive tax—average tax rate declines as income increases

• Proportional tax—average rate stays the same as income increases

12-15LO2

Apportioning the Tax Burden

• Applications

• Personal income tax: progressive

• Sales tax: regressive

• Corporate tax: proportional

• Payroll tax: regressive

12-16

• Tax incidence

• Who really pays the tax?

• Excise tax

• Tax burden depends on elasticity

• Inelastic versus elastic

• Efficiency loss

• Deadweight loss

• Transfer of surplus to government

Tax Incidence and Efficiency Loss

LO3

12-17

Elasticity and Tax Incidence

14

12

10

8

6

4

2

0

5 10 15 20 25 Q

PP

rice

(p

er b

ott

le)

Quantity(millions of bottles per month)

S

D

St

Tax $2

LO3

12-18LO3

Elastic Demand Inelastic Demand

Tax

a

b

c

a

b

0Q2

P1

Q1

P

Pe

Smaller efficiency loss with inelastic demand

St

S

De

Di

c

S

Tax St

P1

PPb

Q2 Q1

Pa

P

Elasticity and Tax Incidence

12-19

Elastic Supply Inelastic Supply

Smaller efficiency loss with inelastic supply

D D

S

SSt

St

P1Pa

PeP1

Pb

Pi

Q1Q2 Q1Q2

Tax

Tax

aa

bb

c

c

LO3

Elasticity and Tax Incidence

0

P P

0 QQ

12-20

Efficiency Loss of a Tax

Pri

ce (

per

bo

ttle

)

Quantity(millions of bottles per month)

S

D

St

Tax $2

Tax paidby consumers

5 10 15 20 25 Q

P

14

12

10

8

6

4

2

0

Tax paidby producers

Efficiency loss (ordeadweight loss)

LO3

12-21LO3

Global Snapshot

12-22LO3

Type of tax Probable Incidence

Personal income tax

Tax falls on the household or individual on which it is levied

Payroll taxes Workers pay the full tax levied on their earnings and partof the tax levied on their employers

Corporate income tax

Short run: Full tax falls on owners of the businessesLong run: Some of the tax may be borne by workers through lower wages

Sales tax Tax falls on consumers who buy the taxed products

Specific excise taxes

Taxes fall on consumers, producers, or both, depending on elasticity of supply and demand

Property Taxes Taxes fall on owners in the case of land and owner-occupied residences, tenants in the case of rented property, consumers in the case of business property

Probable Incidence of U.S. Taxes

12-23

U.S. Tax Structure

• Federal tax system is progressive

• State and local tax structures are largely regressive

• Overall U.S. tax system is progressive

LO3