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Government Revenue and Spending
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Chapter 14: Government Revenue and
Spending
KEY CONCEPT
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A tax is a mandatory payment to local, state, or national government,
while revenue is government income from taxes and other nontax
sources.
WHY THE CONCEPT MATTERS
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Taxes, such as income tax and sales tax, are a part of everyday life.
The revenues raised from these taxes fund programs and services
government provides. These programs and services include
highways, police, and parks.
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How Taxes Work
Government Revenue
KEY CONCEPTS
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Government provides public goods, aid for people in need
Revenue—government income from tax and non-tax sources
– tax is mandatory payment to local, state, or national government
– Non-tax sources include borrowing and lotteries
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Government Revenue
Principles of Taxation
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Benefits-received principle: people who benefit directly should pay
– amount paid should be in proportion to benefits received
Ability-to-pay principle: benefits received should not matter
– amount taxed should depend on person’s ability to pay
– question arises: should everyone pay the same percentage of
income?
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Government Revenue
Criteria for Taxation
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Equity—tax applied uniformly; people in same situations pay the
same
Simplicity—easy for taxpayer to understand and government to
collect
Efficiency—how well tax raises revenue with least administrative cost
– also, how small the effort and expense required to pay the tax
Criteria sometimes conflict; a given tax may not meet all
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Tax Bases and Structures
KEY CONCEPTS
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Tax base—each type of wealth subject to taxes
Most common: individual income, corporate income, sales, property
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Tax Bases and Structures
Tax Bases
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Individual income tax—on income from all sources
Corporate income tax—on corporation’s profits
Sales tax—on value of product; a percentage of sale price
Property tax—on value of assets, generally real estate; part of rent
Growing, shrinking tax base means changes in amount of taxable
wealth
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Tax Bases and Structures
Tax Structures
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Proportional tax—flat tax—all taxpayers pay same percentage of
income
Progressive tax—higher income earners pay higher percentage of
income
– most closely linked to ability-to-pay principle
Regressive tax—lower income earners pay higher percentage of
income
– examples: sales tax, property tax
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Who Pays the Tax?
KEY CONCEPTS
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Incidence of a tax—final burden of the tax or impact on taxpayer
– measured by who actually pays tax
– business tax may get passed on to consumer as higher prices
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Who Pays the Tax?
Effect of Elasticity on Taxes
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If product has elastic demand, seller pays more of tax
– reason: quantity demanded will decrease if prices rise
If product has inelastic demand, consumer pays more of tax
– reason: quantity demanded will decrease only slightly
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Impact of Taxes on the Economy
KEY CONCEPTS
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Taxes impact resource allocation, productivity, growth, behavior
Government chooses what to tax, how to tax based on
– income it wants to raise
– economic effects it wants to achieve
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Impact of Taxes on the Economy
Impact 1: Resource Allocation
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Tax on a good or service increases cost of production
If demand remains same, price will go up
– probable shift in resources
If supplier unable to pass increased costs to consumer
– may shift production to another, more profitable good or service
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Impact of Taxes on the Economy
Impact 2: Productivity and Growth
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When taxes on interest and dividends high, people save less
– impacts amount of money available to producers to invest in
businesses
Some economists think high taxes reduce incentives to work
Others think high taxes promote underground economy
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Impact of Taxes on the Economy
Impact 3: Economic Behavior
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Tax incentive—use of taxes to influence economic behavior
Tax credits, rebates encourage behavior good for society, economy
Sin taxes imposed on unhealthful, damaging products, activities
– demand relatively inelastic; is more elastic with steep tax increase
– very large increase may keep tax revenues up in spite of lower
demand
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Reviewing Key Concepts
Explain the differences between the terms in each of
these pairs:
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tax and revenue
sales tax and property tax
progressive tax and regressive tax
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Federal Taxes
Individual Income Tax
KEY CONCEPTS
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Federal government gets about $2.5 trillion in revenue yearly
Taxes important sources of revenue
– largest source is individual income tax
– second largest source is social insurance taxes
– other tax sources: corporate income, estate, gift, excise, customs
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Individual Income Tax
EXAMPLE: Paying Your Taxes
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Withholding—payroll tax taken before worker gets paycheck
Internal Revenue Service (IRS) collects money, administers tax
system
Taxable income—taxable portion; exemptions, deductions reduce it
Tax returns—forms used to report income, taxes owed to government
– if too much withheld, taxpayer gets refund; if not enough, taxpayer
pays rest
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Individual Income Tax
EXAMPLE: Indexing
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Federal income tax is progressive—rates go up as taxable income
does
Tax bracket—tax rate for an income span
Indexing revises tax brackets, prevents higher taxes due to inflation
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FICA: Taxes to Ease Hardships
KEY CONCEPTS
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FICA—Federal Insurance Contributions Act; employers, workers both
pay
– Social Security aids older citizens, disabled, children who lost
parent
– Medicare is national health insurance mainly for people over 65
Unemployment compensation for limited time aids workers who lost
job
– administered by states; employers pay
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Corporate Income and Other Taxes
KEY CONCEPTS
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Other federal taxes:
– corporate income, estate, gift, excise, customs duties, and user fee
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Corporate Income and Other Taxes
Corporate Income Taxes
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Corporate income is third largest source of federal tax revenue
8 percent of all businesses that file returns subject to this tax
Corporations deduct expenses, such as equipment, research
Common criticism: double taxation of corporate profits, shareholders
– capital gains tax rate has decreased in response
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Corporate Income and Other Taxes
Other Taxes
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Estate tax—on property transferred to others after owner’s death
Gift tax—on money or property given by one living person to another
Excise tax—on production or sale of specific product, such as gas
Customs duty—on goods imported from other countries
User fee—charged for use of good or service, such as parking
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Maya MacGuineas: Reforming the Tax System
A Tax Revolution?
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Tax policy analyst—wants new tax system, more responsible
budgeting
End most deductions, exemptions; restructure entitlement programs
Phase out corporate tax; change estate tax; add environmental taxes
Replace FICA taxes with progressive consumption tax tied to
spending
– would also be incentive to save
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Reviewing Key Concepts
Explain the relationship between the terms in each of
these pairs:
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taxable income and tax return
FICA and Social Security
estate tax and gift tax
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Federal Government Spending
Federal Expenditures
KEY CONCEPTS
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Mandatory spending—required by current law
– examples: Social Security, Medicare
Discretionary spending—must be authorized each year
– examples: highway construction, maintenance of national parks
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Federal Expenditures
Type 1: Mandatory Spending
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Entitlements—social welfare programs with specific requirements
Social Security restrictions: former worker, age, extra income limit
Medicare provides hospital, other medical insurance; means tested
Medicaid is federal-state insurance program for low-income people
Other programs’ funding based on number of people eligible
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Federal Expenditures
Type 2: Discretionary Spending
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Defense includes salaries, weapons, military bases, homeland
security
Interstate highway system and other transportation
Natural resources, environment; includes: parks, pollution clean up
Education; science, space, technology; other research
Justice administration includes enforcement agencies, federal courts
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The Federal Budget and Spending
KEY CONCEPTS
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Federal budget—plan for spending federal revenue
Fiscal year—12-month period for which expenditures are planned
– federal fiscal year is October 1 through September 30
President’s budget prepared by Office of Management and Budget
(OMB)
– uses estimated tax receipts, requests of federal departments,
agencies
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The Federal Budget and Spending
Congress Acts on the Budget
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Congressional Budget Office helps develop appropriations guidelines
– appropriations are specific amounts set aside for specific
purposes
Members of Congress make deals to get votes for their
appropriations
Congress votes on budget, sends to President for approval
– can pass resolutions for day-to-day running if no budget by
October 1
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The Federal Budget and Spending
Methods of Federal Spending
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Direct spending—for goods, services government uses to operate
Transfer payment—to taxpayers who do not provide goods, services
– generally mandatory spending, such as Social Security
Grant-in-aid—transfer payment to state, local government, regions
– include highway construction, some school services, Medicaid
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The Federal Budget and Spending
The Impact of Federal Spending
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Private sector—part of economy owned by individuals, businesses
Resource allocation—government decides where, on what to spend
money
– influences how resources are allocated
Income redistribution—through transfer payments, work contract
awards
Competition with the private sector—by producing same goods,
services
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Reviewing Key Concepts
Explain the relationship between the terms in each of
these pairs:
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mandatory spending and entitlement
federal budget and fiscal year
transfer payment and grant-in-aid
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State and Local Taxes
and Spending
State Revenues
KEY CONCEPTS
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Federal government has broadest tax base; local has smallest
Local governments: towns, cities, counties, issue specific districts
Main state revenue sources: federal government, sales, income taxes
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State Revenues
Type 1: Sales and Excise Taxes
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Almost all states have sales tax on most goods, services
– many states exempt food, medicines; some have lower tax
– many exempt charitable, religious, educational groups
All have excise taxes on cigarettes, alcohol, gasoline, diesel
Many have sales taxes on car rentals, hotel rooms
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State Revenues
Type 2: Income Tax and Other Revenue Sources
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Most states levy individual, corporate income tax; about 16 percent of
revenue
Most have progressive rates on individual, flat on corporate
Many structure tax rates to attract businesses to the state
States have other revenue sources:
– estate, property taxes; user, business registration, license fees
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State Budgets and Spending
KEY CONCEPTS
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Balanced budget—total spending equals total revenue
– usually applies only to certain kinds of spending
– states can dip into reserve fund, run surplus to use in later years
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State Budgets and Spending
State Budgets
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Operating budget covers day-to-day expenses; usually must be
balanced
– includes salaries; health, welfare payments; education
Capital budget covers major expenses or investments
– no balanced-budget requirements; usually funded by borrowing
– includes large construction, maintenance projects, land acquisition
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State Budgets and Spending
State Expenses
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Education—community colleges, state universities, local school aid
Public safety—state police, crime labs, correctional facilities
Public welfare—hospitals; cash assistance, medical payments for
needy
Social problems—housing, disability, unemployment, job training
Court system; administration; natural resources; economic
development
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Local Revenue and Spending
KEY CONCEPTS
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Local government units include:
– county, city, town, village, township, school and special districts
Fewer options for raising revenue than other levels of government
– major revenue sources are state and federal transfers, property
taxes
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Local Revenue and Spending
Property Tax
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Levied on real estate, motor vehicles, boats, jewelry, computers
Tax assessor—official who determines value of property
Tax based on a percentage of property’s value
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Local Revenue and Spending
Other Taxes
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Local governments use sales, sin, hospitality, entertainment taxes
Payroll tax levied by cities on workers who live outside the city
– workers benefit from city services, such as police, fire protection
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Local Revenue and Spending
Local Spending
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Public schools—elementary and secondary
Safety—police, fire, emergency medical, disaster help; animal control
Welfare—health departments, hospitals
Utilities—water, transit systems, sewage, trash removal
Local roads, streets; recreational, cultural facilities
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Reviewing Key Concepts
Use each term in a sentence that illustrates the meaning
of the term:
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balanced budget
capital budget
tax assessor
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Should Online Sales Be Taxed?
Background
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In 1992, the Supreme Court upheld a law making Internet retailers
exempt from collecting most sales taxes because rules varied widely
among states.
Today, tax collection is simpler, and Internet purchases are
commonplace. Most states have made tax on Internet sales
voluntary, with poor results.
What’s the Issue?
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Should there be sales tax on Internet purchases?
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Should Online Sales Be Taxed? {continued}
Thinking Economically
1. Summarize the arguments for and against an Internet sales tax as
presented in the documents.
2. Who is most likely to benefit from Internet sales tax revenue? Explain
your answer, using information from the documents.
3. How has government responded to e-commerce—the selling of
goods and services online? Use information from the documents in
your answer.
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