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Chapter 15
Financing Government: Taxes
and Debt
Economic Principles
Commandeering resources
Commandeering money (taxes)
Regressive, proportional, and
progressive tax structures
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Economic Principles
Social Security taxes
Government securities and
public debt
Internally and externally
financing the debt
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EXHIBIT 1 PRODUCTION POSSIBILITIES CURVE
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Exhibit 1: Production Possibilities Curve
What is the opportunity cost of
producing the first aircraft in
Exhibit 1?
• The opportunity cost of producing the first
aircraft is 500 houses.
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Commandeering Resources
What is the most direct method
available for a government to
acquire resources?
• The most direct method is to commandeer
resources.
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Commandeering Resources
What is the most direct method
available for a government to
acquire resources?
• This is how the pharaohs built the
pyramids, and how governments built
roads during the Middle Ages.
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Commandeering Resources
What is the most direct method
available for a government to
acquire resources?
• The military draft is a modern form of
commandeering resources for the military.
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The Tax System
How is the tax system related to
commandeering resources?
• The tax system commandeers money, not
resources. Remember that resources are
land, labor, capital, and entrepreneurship.
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There’s More Than One Way to
Levy Taxes
Poll tax
• A tax of a specific absolute sum levied on
every person or every household.
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There’s More Than One Way to
Levy Taxes
Regressive income tax
• A tax whose impact varies inversely with
the income of the person taxed. Poor people
have a higher percentage of their income
taxed than do rich people.
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There’s More Than One Way to
Levy Taxes
1. What is an example of a
regressive income tax?
• One example is a poll tax.
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There’s More Than One Way to
Levy Taxes
1. What is an example of a
regressive income tax?
• Another example is a tax on consumption,
such as a sales tax. Since poor people spend
all of their income on consumption, while
rich people save a portion of their income, a
consumption tax is regressive.
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There’s More Than One Way to
Levy Taxes
Proportional income tax
• A tax that is a fixed percentage of income,
regardless of the level of income.
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There’s More Than One Way to
Levy Taxes
2. What is an example of a
proportionate income tax?
• A flat-rate tax on personal income
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There’s More Than One Way to
Levy Taxes
Progressive income tax
• A tax whose rate varies directly with the
income of the person being taxed. Rich
people pay a higher tax rate—a larger
percentage of their income is taxed—than
do poor people.
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There’s More Than One Way to
Levy Taxes
3. What is an example of a
progressive income tax?
• The current system of federal income
taxation is progressive.
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There’s More Than One Way to
Levy Taxes
Corporate income tax
• A tax levied on a corporation’s income
before dividends are distributed to
stockholders.
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Are We Really Paying High Taxes?
True or false: Taxes as a percentage
of GDP are higher in the U.S. than
in any other rich industrialized
country.
• False
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Are We Really Paying High Taxes?
True or false: Taxes as a percentage
of GDP are higher in the U.S. than
in any other rich industrialized
country.
•Tax revenues in the U.S. were 34.3 percent
of GDP.
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Are We Really Paying High Taxes?
True or false: Taxes as a percentage
of GDP are higher in the U.S. than
in any other rich industrialized
country.
• In comparison, tax revenues as a
percentage of GDP were 40.6 in the
United Kingdom, 43.4 in Canada, 45.1
in Germany, and 51.1 in France.
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There’s More Than One Way to
Levy Taxes
Property tax
• A tax levied on the value of physical assets
such as land, or financial assets such as
stocks and bonds.
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There’s More Than One Way to
Levy Taxes
Unit tax
• A fixed tax in the form of cents or dollars
per unit, levied on a good or service.
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There’s More Than One Way to
Levy Taxes
Sales tax
• A tax levied in the form of a specific
percentage of the value of the good or
service.
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There’s More Than One Way to
Levy Taxes
Customs duty
• A sales tax applied to a foreign good or
service.
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There’s More Than One Way to
Levy Taxes
Excise tax
• Any tax levied on a good or service, such
as a unit tax, a sales tax, or a customs duty.
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There’s More Than One Way to
Levy Taxes
5. Which of the following is a unit
tax?
a. A 7% tax on gasoline sales.
b. A $10 tax on fishing rods.
c. A 20% flat tax on income.
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There’s More Than One Way to
Levy Taxes
5. Which of the following is a unit
tax?
a. A 7% tax on gasoline sales.
b. A $10 tax on fishing rods.
c. A 20% flat tax on income.
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EXHIBIT 2 2003 TAX RATE SCHEDULE FOR MARRIED
PERSONS FILING JOINTLY
Source: Internal Revenue Service, Instructions for Form 1040 (Washington, D.C.: Department of the
Treasury, 2003), p. 13.
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Exhibit 2: 2003 Tax Rate Schedule for
Married Persons Filing Jointly
Suppose that a married couple filing
jointly had $100,000 in taxable income.
According to Exhibit 2, how much
federal income tax must this couple pay?
• On the first $7,000 they pay 10%,
which equals $700.
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Exhibit 2: 2000 Tax Rate Schedule for
Married Persons Filing Jointly
Suppose that a married couple filing
jointly had $100,000 in taxable income.
According to Exhibit 2, how much
federal income tax must this couple pay?
• On the next $21,400 they pay 15%, which
equals $3,200.
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Exhibit 2: 2000 Tax Rate Schedule for
Married Persons Filing Jointly
Suppose that a married couple filing
jointly had $100,000 in taxable income.
According to Exhibit 2, how much
federal income tax must this couple pay?
10100
• On the next $40,400 they pay 25%, which
equals $10,100.
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Exhibit 2: 2000 Tax Rate Schedule for
Married Persons Filing Jointly
Suppose that a married couple filing
jointly had $100,000 in taxable income.
According to Exhibit 2, how much
federal income tax must this couple pay?
10100
• On the final $31,100 they pay 28%, which
equals $10,296.
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Exhibit 2: 2000 Tax Rate Schedule for
Married Persons Filing Jointly
Suppose that a married couple filing
jointly had $100,000 in taxable income.
According to Exhibit 2, how much
federal income tax must this couple pay?
• Thus the married couple pays a total of
$(700 + $3210 + $10,100 + 8,736) = $22,746.
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EXHIBIT 3 FEDERAL, STATE, AND LOCAL GOVERNMENT
REVENUES: 2002 ($ BILLIONS)
Source: Survey of Current Business (Washington, D.C.: U.S. Department of Commerce, October 2003).
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Exhibit 3: Federal, State, and Local Government
Revenues: 2002 ($ billions)
Income taxes are the largest single
source of combined government
tax revenues.
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Financing Government Spending
Through Debt
Public debt
• The total value of government securities—
Treasury bills, notes, and bonds—held by
individuals, businesses, other government
agencies, and the Federal Reserve.
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EXHIBIT 5 OWNERSHIP OF THE U.S. PUBLIC DEBT: 2002
(PERCENTAGE OF TOTAL)
*Savings and loan associations, nonprofit institutions, credit unions,
certain U.S. Treasury deposit accounts, and federally sponsored agencies.
Source: Federal Reserve Bulletin (Washington, D.C., October 2003).
mutual
savings
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banks,
corporate
pension
trust
funds,
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EXHIBIT 6A THE FEDERAL DEBT
Source: Statistical Abstract of the United States, 2000 (Washington, D.C.: U.S. Department of Commerce, 2000).
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EXHIBIT 6B THE FEDERAL DEBT
Source: Statistical Abstract of the United States, 2000 (Washington, D.C.: U.S. Department of Commerce, 2000).
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Exhibit 6: The Federal Debt
1. During what time period did
the gross federal debt grow most
rapidly?
• During the period between approximately
1980 and 2000.
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Exhibit 6: The Federal Debt
2. Based on the data in panel b of
Exhibit 6, in what year was federal
debt as a percentage of GDP the
largest?
• 1945. Spending on the war effort caused
federal debt to be 125 percent of GDP.
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Exhibit 6: The Federal Debt
3. True or false: Gross federal debt
as a percentage of GDP has
increased sharply during the 1990s.
• False. Gross federal debt as a percentage
of GDP flattened out and then declined in
the 1990s.
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Exhibit 6: The Federal Debt
4. Compare panels a and b in
Exhibit 6. What caused debt as a
percentage of GDP to flatten out
and then decline in the 1990s?
• Panel a shows that the gross federal
debt increased through 1996.
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Exhibit 6: The Federal Debt
4. Compare panels a and b in
Exhibit 6. What caused debt as a
percentage of GDP to flatten out
and then decline in the 1990s?
• In order for debt as a percentage of GDP
to flatten out when debt is still growing,
GDP must grow as fast as debt.
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Exhibit 6: The Federal Debt
4. Compare panels a and b in
Exhibit 6. What caused debt as a
percentage of GDP to flatten out
and then decline in the 1990s?
• In the late-1990s gross federal debt
actually began to decline.
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EXHIBIT 7
GROSS PUBLIC DEBT AS A PERCENT OF GDP
FOR SELECTED ECONOMIES: 1998
Source: Statistical Abstract of the United States, 2000 (Washington, D.C.: U.S. Department of Commerce, 2000), p. 847.
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Does Debt Endanger Future
Generations?
In one sense the answer is no. While
the interest on future government
debt must be paid by taxing the
future economy, people in the future
who own government bonds receive
that interest as income.
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Does Debt Endanger Future
Generations?
In another sense the answer is yes.
For example, if future bondholders
are rich, then the rich receive the
interest income while the poor only
bear the burden of higher taxes.
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Does Debt Endanger Future
Generations?
In addition, increased government
debt purchased by the Fed will
increase the money supply, which
can be inflationary.
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Does Debt Endanger Future
Generations?
Another problem with increased
government debt is that it tends to crowd
out private investment, which slows the
rate of economic growth.
Debt promotes overconsumption since
bond holders are not aware the source of
interest is from the tax they pay.
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Does Debt Endanger Future
Generations?
External debt
• Public debt held by foreigners.
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Does Debt Endanger Future
Generations?
Recall from Exhibit 5 that foreigners
are a major owner of U.S. public
debt. In this case, future generations
of U.S. citizens bear the burden of
higher taxes to pay the interest that
flows to foreigners.
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