Download Economics for Today 2nd edition Irvin B. Tucker

Chapter 22
The Public Sector
• Key Concepts
• Summary
• Practice Quiz
• Internet Exercises
©2000 South-Western College Publishing
1
In this chapter, you will
learn to solve these
economic puzzles:
How
the
How
Should
doesdoes
we
the replace
tax Social
burden
the of
Is atax
flatStates
taxfavor
fair?
tax
the
income
theSecurity
United
with
a compare
national
upper-income
worker?
sales
to other
tax orcountries?
a flat
tax?
2
What is the purpose
of this chapter?
To examine public-sector
decisions of politicians,
government bureaucrats,
voters, and special
interest groups
3
What has happened to
the size of Government?
Since the 1950’s,
government expenditures
have grown from about
one-quarter to over one
third of GDP
4
50%
45%
40%
35%
30%
25%
20%
15%
10%
5%
Government Expenditures 1935 - 1998
Total government expenditures
Federal government expenditures
Year
35 40 45 50 55 60 65 70 75 80 85 90 95 00
5
1970 Federal Outlays
3% 2%
22%
Other
5%
3%
International affairs
5%
Veteran's benefits
Agriculture
11%
Transportation
Education and health
9%
40%
Interest on federal debt
National defense
Income security
6
1998 Federal Outlays
2.0% 1.0% 2.5%
Other
1.0%
International affairs
2.5%
11.0%
Veteran's benefits
Agriculture
49.0%
15.0%
Transportation
Education and health
Interest on federal debt
16.0%
National defense
Income security
7
1970 State & Local Outlays
Other
20%
Civilian safety
40%
Highways
8%
Health & hospitals
11%
13%
8%
Income security
Education
8
1995 State & Local Outlays
Other
26%
Civilian safety
33%
Highways
Health & hospitals
8%
Public Welfare
7%
17%
9%
Education
9
Federal Receipts 1998
5%
Other
3%
11%
Excise taxes
Corporate income taxes
48%
Social insurance taxes
33%
Individual income taxes
10
State & Local Receipts 1998
Other
24%
Corporate income taxes
39%
Individual income taxes
Property taxes
19%
3%
15%
State sales tax
11
How do taxes in the
U.S. compare to taxes
in other countries?
U.S. citizens are among the
most lightly taxed people
in the industrialized world
12
Tax Burden 1998
70%
60%
50%
40%
30%
20%
Sweden
France
Italy
Germany
Canada
U.K.
U.S.
Japan
10%
0%
13
50% Growth in Taxes in the U.S., 1935 - 1998
45%
Total government taxes
40%
35%
30%
25%
20%
15%
10%
Federal government taxes
5%
Year
35 40 45 50 55 60 65 70 75 80 85 90 95 00
14
How does the
Government decide
which tax is appropriate?
Benefits received
Ability to pay
15
What is the Benefits
Received Principle?
The concept that those
who benefit from
government expenditures
should pay the taxes that
finance their benefits
16
What is the Ability
to Pay Principle?
The concept that those who
have higher incomes can
afford to pay a greater
proportion of their
income in taxes,
regardless of the benefits
17
Which principle
dominates in the U.S.?
The ability-to-pay principle
dominates the benefitsreceived principle
18
What is a
Progressive Tax?
A tax that charges a
higher percentage of
income as income rises
19
What is the
Average Tax Rate?
Total tax due divided by
total taxable income
20
What is the
Marginal Tax Rate?
The change in taxes due
divided by the change
in taxable income
21
What is a
Regressive Tax?
A tax that charges a
lower percentage of
income as income rises
22
What is a
Proportional Tax?
A tax that charges the
same percentage of
income, regardless of
the size of income
23
What is a Flat Rate Tax?
Same as a proportional tax
24
Federal Individual Income Tax Rate
Schedule for a Single Taxpayer, 1998
Taxable Income
Marginal Tax Rate
0 — $23,350
15.0%
$23,350 — $61,400
28.0%
$61,400 — $128,100
$128,100 — $278,450
31.0%
$278,450 + —
36.0%
39.6%
25
What is
Public Choice Theory?
The analysis of the
government decisionmaking process to allocate
resources
26
Who is James Buchanan?
The founder of public
choice theory which
applies economic
analysis to politics
27
What is the
Benefit - Cost Analysis?
The comparison of the
additional rewards and costs
of an economic alternative
28
What is the basic Rule of
Benefit-cost Analysis?
A firm will produce
additional units as long
as marginal benefit
exceeds the marginal cost
29
Why might Government
be Inefficient in solving
Society’s Problems?
• Majority rule problem
• Special interest effect
• Rationale ignorance
• Bureaucratic inefficiency
• Shortsightedness effect
30
What is the
Majority Rule Problem?
Voting can lead to a rejection
of projects with marginal
total benefits exceeding the
marginal cost
31
Can Majority Rule lead
to inefficient solutions?
Yes, “one person one
vote” cannot measure
the intensity of voters’
preferences as well as
the market
32
What is the SpecialInterest Group Effect?
Special-interest groups can
create government support
for programs with costs
out-weighing their benefits
33
Why can Special-Interest
Voting be inefficient?
A small group within
the society can benefit
while the whole society
pays the costs
34
What is
Rational Ignorance?
The voters choose to remain
uninformed because the
marginal cost of obtaining
information is higher than
the marginal benefit from
knowing it
35
What is Bureaucratic
Inefficiency?
The bureaucracy may
become more powerful
than elected officials
36
What is the
Shortsightedness Effect?
Democracy has a bias toward
programs offering clear
benefits and hidden costs
37
Key Concepts
38
Key Concepts
• What has happened to the size of
Government?
• How do taxes in the U.S. compare to
other countries?
• What is the Benefits Received Principle?
• What is the Ability to Pay Principle?
• What is a Progressive Tax?
39
Key Concepts cont.
•
•
•
•
•
•
•
•
What is the Marginal Tax Rate?
What is a Regressive Tax?
What is a Proportional Tax?
What is the Majority Rule Problem?
What is the Special-Interest Group Effect?
What is Rational Ignorance?
What is Bureaucratic Inefficiency?
What is the Shortsightedness Effect?
40
Summary
41
Government expenditures
represented a rising share of GDP
from the 1950’s to 1985 compared
to private-sector spending. The
major source of the growth in the
public sector is transfer programs,
officially tabulated in a category
called income security. After 1985,
government outlays decreased as a
percentage of GDP.
42
50%
45%
40%
35%
30%
25%
20%
15%
10%
5%
Government Expenditures 1935 - 1998
Total government expenditures
Federal government expenditures
Year
35 40 45 50 55 60 65 70 75 80 85 90 95 00
43
Federal tax revenues are the
primary source of revenue for all
federal government units. The most
important taxes at the federal level are
the individual income tax and payroll
taxes. Although not a tax revenue,
borrowing has become the federal
government’s third largest method of
collecting funds.
44
50% Growth in Taxes in the U.S., 1935 - 1998
45%
Total government taxes
40%
35%
30%
25%
20%
15%
10%
Federal government taxes
5%
Year
35 40 45 50 55 60 65 70 75 80 85 90 95 00
45
State and local government tax
revenues consist primarily of sales
and property taxes. While states rely
on income taxes for revenue, they
also collect sales and excise taxes.
In addition, state budgets depend
greatly on charges and revenuesharing grants from the federal
government.
46
Local governments collect
most of their tax revenue from
property taxes, but the majority of
their receipts are from charges and
grants from the federal and state
governments.
47
The taxation burden, measured
by taxes as a percentage of GDP, is
lighter in the U.S. than many other
advanced industrial countries. Since
1960, federal taxes have remained a
fairly constant fraction of GDP.
State and local taxes, however, have
generally increased as a percentage
of GDP since the 1950’s
48
Tax Burden 1998
70%
60%
50%
40%
30%
20%
Sweden
France
Italy
Germany
Canada
U.K.
U.S.
Japan
10%
0%
49
The benefits-received principle
and the ability-to-pay principle are the
two basic philosophies of taxation
fairness. The gasoline tax is a classic
example of the benefits-received
principle because users of the
highways pay the gasoline tax.
Progressive income taxes follow the
ability-to-pay principle because there
is a direct relationship between the
average tax rate and income size.
50
Sales, excise, and flat-rate
taxes are examples of a regressive
tax because each results in a greater
burden on the poor than the rich.
51
Public choice theory reveals the
government decision making process.
For example, government failure can
occur for any of the following reasons:
52
(1) Majority voting may not follow
benefit-cost analysis, (2) special interest
groups can obtain large benefits and
spread their costs over many taxpayers,
(3) rational voter ignorance means a
sizeable portion of the voters will decide
not to make informed judgements, (4)
bureaucratic behavior may not lead to
cost effectiveness, an (5) politicians
suffer from a short time horizon, leading
to a bias toward hiding the costs of
programs.
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Chapter 22 Quiz
©2000 South-Western College Publishing
54
1. From 1950 to the late-1990s, total government
expenditures as a percentage of GDP in the
United States
a. fell by half.
b. remained fairly constant.
c. grew from one-fourth to one-half.
d. grew from one-quarter to one-third.
D.
55
50%
45%
40%
35%
30%
25%
20%
15%
10%
5%
Government Expenditures 1935 - 1998
Total government expenditures
Federal government expenditures
Year
35 40 45 50 55 60 65 70 75 80 85 90 95 00
56
2. Which of the following accounted for the
second largest percentage of total federal
government expenditures as of 1999?
a. Income security.
b. National defense.
c. Interest on the national debt.
d. Education and health.
B
57
1998 Federal Outlays
2.0%1.0%2.5%
Other
1.0%
2.5%
International affairs
11.0%
Veteran's benefits
Agriculture
49.0%
15.0%
Transportation
Education and health
Interest on federal debt
16.0%
National defense
Income security
58
3. Which of the following contributed the
second largest percentage of total state and
local government revenues in 1999
(excluding “Other Categories”)?
a. Corporate income taxes.
b. Sales and excise taxes.
c. Individual income taxes.
d. Property taxes.
D
59
State & Local Receipts 1998
Other
24%
Corporate income taxes
39%
Individual income taxes
Property taxes
19%
3%
15%
State sales tax
60
4. Which of the following countries devotes
about the same percentage of its GDP to
taxes as the United States?
a. Sweden.
b. Italy.
c. United Kingdom.
d. Japan.
D.
61
Tax Burden 1998
70%
60%
50%
40%
30%
20%
Sweden
France
Italy
Germany
Canada
U.K.
U.S.
Japan
10%
0%
62
5. “The poor should not pay income taxes.”
This statement reflects which of the following
principles of taxation?
a. Fairness of contribution.
b. Benefits received.
c. Inexpensive to collect.
d. Ability to pay.
D. Since the poor lack the ability to pay, the
tax system should be designed so they pay
less taxes than people with higher incomes.
63
6. Some cities finance their airports with a
departure tax: Every person leaving the city
by plane is charged a small fixed dollar
amount that is used to help pay for building
and running the airport. The departure tax
follows the
a. benefits-received principle.
b. ability-to-pay principle.
c. flat-rate principle.
d. public-choice principle.
A. Those persons who are gaining the most
from the airport are the ones who are
paying the most for it.
64
7. Which of the following statements is true?
a. The most important source of tax revenue
to the federal government is individual
income taxes.
b. The most important sources of tax revenue
to state and local governments are sales and
property taxes.
c. The most important source of tax revenue
to local governments is local property taxes.
d. The taxation burden, measured by taxes as
a percentage of GDP, is lighter in the U.S.
than in most other advanced industrial
countries.
e. All of the above are true.
E
65
8. Which of the following statements is true?
a. A sales tax on food is a regressive tax.
b. The largest source of federal government
tax revenue is individual income taxes.
c. The largest source of state and local
government tax revenue is sales taxes.
d. All the above are true statements.
D. All the above are true
statements.
66
9. A tax that is structured so that people with
higher incomes pay a larger percentage of
their income for the tax than do people with
smaller incomes is called a (an)
a. income tax.
b. regressive tax.
c. property tax.
d. progressive tax.
D. Answer a is not specific; b is the
opposite principle, and c is based on
property not income.
67
10. Generally, most economists feel that a
______type of income tax is a fairer way to
raise government revenue than a sales tax.
a. Regressive.
b. Proportional.
c. Flat-rate.
d. Progressive.
D. A progressive tax is argued to be fair
because people with higher incomes
pay more tax.
68
11. The federal personal income tax is an
example of a (an)
a. excise tax.
b. proportional tax.
c. progressive tax.
d. regressive tax.
C. Since the marginal tax rate increases
with income, the federal personal income
tax is a progressive tax.
69
12. A 5 percent sales tax on food is an
example of a
a. flat tax.
b. progressive tax.
c. proportional tax.
d. regressive tax.
D. A sales tax on food is a regressive tax
because people with higher incomes do not
spend proportionately more on food.
70
13. Margaret pays a local income tax of 2
percent, regardless of the size of her income.
This tax is
a. proportional.
b. regressive.
c. progressive.
d. a mix of (a) and (b).
A. Less tax is paid by a regressive tax and
more tax is paid by a progressive tax as
people’s incomes rise.
71
14. Which of the following statements relating to
public choice is true?
a. A low voter turnout may result when voters
perceive that the marginal cost of voting
exceeds its marginal benefit.
b. If the marginal cost of voting exceeds its
marginal benefit, the vote is unimportant.
c. Special-interest groups always cause the will
of a majority to be imposed on a minority.
d. All of the above.
A. This is the rational ignorance public choice
theory.
72
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END
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