Download Chapter 7 - McGraw Hill Higher Education

Chapter 7
The Government Sector
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
7-1
Chapter Objectives
•
•
•
•
•
•
•
Government spending
The graphing of the C + I + G line
Types of taxes
The average and marginal tax rates
Sources of government revenue
Principles of taxation
The economic role of government
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
7-2
Introduction: The Growing
Economic Role of Government
• Most of the growth over the past seven decades
was due to the Depression and World War II
• Since 1945 the roles of government at the
federal, state, and local levels have expanded
– The seeds of that expansion were sown during the
Roosevelt administration
• The government exerts four basic influences
–
–
–
–
It spends more than $2.5 trillion
It levies almost that amount in taxes
It redistributes hundreds of billions of dollars
It regulates our economy
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
7-3
Whe re it com e s from ...
Social
Insurance
Receipts
34%
Corporate
Income
Taxes
10%
Other
4%
Excise
Taxes
4%
Whe re it goe s ...
Individual
Income
Taxes
48%
Fe de ral tax re ve nue :
$2,019 billion
National
Def ense
16%
Non-Def ense
Discretionary
19%
Other
Means-Tested
Entitlements
6%
Other
Mandatory
6%
Medicaid
7%
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Net
Interest
11%
Social
Security
23%
Medicare
12%
Fe de ral s pe nding:
$1,835 billion
7-4
2002 Proposed Spending by Category
Budget of the United States Government , Fiscal Year 1999
International
A f f airs
$21 B (1%)
National
Def ense
$301 B (16%)
Medicare and
Medicaid
$342 B (19%)
A ll Other
Mandatory
$232 B (13%)
Domestic
Discretionary
$309 B (17%)
Social
Security
$422 B (23%)
Net
Interest
$208 B (11%)
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
7-5
State and Local Government
Spending
• Main expenditures
– Education
– Health
– Welfare
• Spending is a little more than half the
level of federal spending
• Police protection and prisons are now
straining state and local budgets
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
7-6
Government Purchases versus
Transfer Payments
• The government spends $2.7 trillion a
year
– GDP = C + I + G + Xn
– Approximately half is “transfer payments”
• The largest transfer payment is social security
• These payments end up in the “C” part GDP
– Approximately half is “government
purchases”
• The largest government purchase is defense
• These end up in the “G” part of GDP
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
7-7
Federal and State and Local Purchases
Relative to GDP, 1960-2000
25
Total Government Purchases
Total government purchases
have been declining since
the late 1960s and now
constitute 16 percent of
GDP
20
15
State and Local Purchases
10
5
Federal Purchases
0
1960 1965 1970 1975 1980 1985 1990 1995
Y ear
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7-8
Federal and State and Local Transfer
Payments as a Percentage of GDP, 1960-2000
Federal transfer payments
have risen sharply since the
mid-1960s, while state and
local transfer payments have
also grown substantially since
the early 1970s.
16
Total Government
Transfer payments
14
State and Local
Transfer Payments
12
10
8
6
Total government transfer
payments have risen from just
6 percent of GDP in 1960 to
more than 15 percent today
4
Federal Transfer Payments
2
0
1960 1965 1970 1975 1980 1985 1990 1995
Year
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
7-9
Graphing the C + I + G + Xn Line
To keep the graph as
simple as possible, we are
assuming the government
spends a constant amount
of money regardless of the
level of disposable income
3,000
C+I+G
C+I
2,000
C
1,000
45û
1,000
2,000
Disposable income ($)
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
3,000
7-10
Graphing the C + I + G + Xn Line
How much is G?
3,000
C+I+G
C+I
2,000
C
Answer: 400
1,000
45û
1,000
2,000
Disposable income ($)
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3,000
7-11
The Average Tax Rate and the
Marginal Tax Rate
This is a hypothetical illustration
Income
Level
Marginal
Tax Rate
Tax
Total
Taxes
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Average
Tax Rate
7-12
The Average Tax Rate and the
Marginal Tax Rate
This is a hypothetical illustration
Income
Level
0 - $100
Marginal
Tax Rate
0 %
Tax
Total
Taxes
0
$0
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Average
Tax Rate
0.0 %
7-13
The Average Tax Rate and the
Marginal Tax Rate
This is a hypothetical illustration
Income
Level
0 - $100
$101 - $200
Marginal
Tax Rate
0 %
Tax
$0
Total
Taxes
$0
Average
Tax Rate
0.0 %
$10
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7-14
The Average Tax Rate and the
Marginal Tax Rate
This is a hypothetical illustration
Income
Level
0 - $100
Marginal
Tax Rate
0 %
$101 - $200
Tax
$0
Total
Taxes
$0
Average
Tax Rate
0.0 %
$10
Additional Taxes Paid
MTR =
( $10)
-------------------------------- ---------Additional Taxable Income ($100)
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7-15
The Average Tax Rate and the
Marginal Tax Rate
This is a hypothetical illustration
Income
Level
Marginal
Tax Rate
Tax
0 - $100
0 %
$0
$101 - $200
10 %
$10
Total
Taxes
$0
Additional Taxes Paid
MTR =
Average
Tax Rate
0.0 %
( $10)
-------------------------------- ---------Additional Taxable Income ($100)
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
7-16
The Average Tax Rate and the
Marginal Tax Rate
This is a hypothetical illustration
Income
Level
Marginal
Tax Rate
Tax
0 - $100
0 %
$0
$101 - $200
10 %
$10
Total
Taxes
$0
Additional Taxes Paid
MTR =
Average
Tax Rate
0.0 %
( $10)
-------------------------------- ----------
Additional Taxable Income ($100)
The Marginal Tax Rate (MTR) is the rate you pay on the last
dollars you earned
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
7-17
The Average Tax Rate and the
Marginal Tax Rate
This is a hypothetical illustration
Income
Level
Marginal
Tax Rate
Tax
Total
Taxes
0 - $100
0 %
$0
$0
$101 - $200
10 %
$10
$10
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Average
Tax Rate
0.0 %
7-18
The Average Tax Rate and the
Marginal Tax Rate
This is a hypothetical illustration
Income
Level
Marginal
Tax Rate
Tax
Total
Taxes
0 - $100
0 %
$0
$0
$101 - $200
10 %
$10
$10
Total Taxes Paid
ATR =
Average
Tax Rate
0.0 %
( $10)
-------------------------------- ---------Entire Income
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
($200)
7-19
The Average Tax Rate and the
Marginal Tax Rate
This is a hypothetical illustration
Income
Level
Marginal
Tax Rate
Tax
Total
Taxes
Average
Tax Rate
0 - $100
0 %
$0
$0
0.0 %
$101 - $200
10 %
$10
$10
5.0 %
Total Taxes Paid
ATR =
( $10)
-------------------------------- ---------Entire Income
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
($200)
7-20
The Average Tax Rate and the
Marginal Tax Rate
This is a hypothetical illustration
Income
Level
Marginal
Tax Rate
Tax
Total
Taxes
Average
Tax Rate
0 - $100
0 %
$0
$0
0.0 %
$101 - $200
10 %
$10
$10
5.0 %
Total Taxes Paid
ATR =
( $10)
-------------------------------- ---------Entire Income
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
($200)
7-21
The Average Tax Rate and the
Marginal Tax Rate
This is a hypothetical illustration
Income
Level
Marginal
Tax Rate
Tax
Total
Taxes
Average
Tax Rate
0 - $100
0 %
$0
$0
0.0 %
$101 - $200
10 %
$10
$10
5.0 %
Total Taxes Paid
ATR =
( $10)
-------------------------------- ---------Entire Income
($200)
The Average Tax Rate (ATR) is the overall rate you pay on
your entire income
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
7-22
The Average Tax Rate and the
Marginal Tax Rate
This is a hypothetical illustration
Income
Level
Marginal
Tax Rate
Tax
Total
Taxes
Average
Tax Rate
0 - $100
0 %
$0
$0
0.0 %
$101 - $200
10 %
$10
$10
5.0 %
$201 - $300
12 %
$12
$22
7.3 %
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
7-23
The Average Tax Rate and the
Marginal Tax Rate
This is a hypothetical illustration
Income
Level
Marginal
Tax Rate
Tax
Total
Taxes
Average
Tax Rate
0 - $100
0 %
$0
$0
0.0 %
$101 - $200
10 %
$10
$10
5.0 %
$201 - $300
12 %
$12
$22
7.3 %
$301 - $400
15 %
$15
$37
9.3 %
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7-24
The Average Tax Rate and the
Marginal Tax Rate
This is a hypothetical illustration
Income
Level
Marginal
Tax Rate
Tax
Total
Taxes
Average
Tax Rate
0 - $100
0 %
$0
$0
0.0 %
$101 - $200
10 %
$10
$10
5.0 %
$201 - $300
12 %
$12
$22
7.3 %
$301 - $400
15 %
$15
$37
9.3 %
$401 - $500
28 %
$28
$65
13.0 %
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
7-25
The Average Tax Rate and the
Marginal Tax Rate
This is a hypothetical illustration
Income
Level
Marginal
Tax Rate
Tax
Total
Taxes
Average
Tax Rate
0 - $100
0 %
$0
$0
0.0 %
$101 - $200
10 %
$10
$10
5.0 %
$201 - $300
12 %
$12
$22
7.3 %
$301 - $400
15 %
$15
$37
9.3 %
$401 - $500
28 %
$28
$65
13.0 %
$501 - $600
50 %
$50
$115
19.2 %
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
7-26
The Average Tax Rate and the
Marginal Tax Rate
This is a hypothetical illustration
Income
Level
Marginal
Tax Rate
Tax
Total
Taxes
Average
Tax Rate
0 - $100
0 %
$0
$0
0.0 %
$101 - $200
10 %
$10
$10
5.0 %
$201 - $300
12 %
$12
$22
7.3 %
$301 - $400
15 %
$15
$37
9.3 %
$401 - $500
28 %
$28
$65
13.0 %
$501 - $600
50 %
$50
$115
19.2 %
> $600
80 %
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7-27
Types of Taxes
• Direct taxes
– A tax with your name on it
• Indirect taxes
– Taxes on things
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7-28
Types of Taxes (Continued)
• Progressive taxes
– Places a greater burden on those best able to pay
and little or no burden on the poor
• Proportional taxes
– Places an equal burden on the rich, the middle class,
and the poor
• Regressive taxes
– Places a heavier burden on the poor than on the rich
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
7-29
a. Nominally
progressive tax
20
16
12
8
4
0
0
20
40
60
80
100
A nnual income ($ thousands)
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
7-30
b. Nominally
proportional tax
20
16
12
8
4
0
0
20
40
60
80
100
A nnual inc ome ($ thousands)
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
7-31
c. Nominally
regressive tax
20
16
12
8
4
0
0
20
40
60
80
100
A nnual inc ome ($ thousands)
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
7-32
Sources of Federal Revenue
• Personal Income Tax
– The personal income tax is the largest source
of federal revenue
– Most of the poor pay little or no federal
income tax
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7-33
Federal Personal Income Tax:The Top
Marginal Tax Rate, 1954-2001
91%
90
80
70
70%
60
50
50%
39.6%
40
30
31%
28%
20
10
1954
1960
1970
1980
*During World War II the top MTR w as 94%.
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
1990
2000
7-34
Top Marginal Tax Rates in 15 Leading
Wealthy Nations, 2000
Top inc ome-tax rate, lates t, %
Netherlands
Denmark
Finland
Sw eden
Belgium
Franc e*
Sw itz erland
Germany **
Spain
Italy
Greec e
Ireland
Britain
Portugal
United States
*Will be 52.5% in 2003.
**Will be 42% by 2005.
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
7-35
Sources of Federal Revenue
• The Social Security and Medicare taxes are the
Payroll Tax
• What you pay is matched by your employer
• The social security tax by law is set at 6.2%
with a wage based limitation of $80,400
• The inflation rate of the previous year raises the wage base
• The Medicare tax of 1.45% applies to wages
and salaries only. Income such as rental
income, interest, dividends, and profit is
exempt
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
7-36
Sources of Federal Revenue
• You pay 6.2% in payroll tax on wages up to
$80,400 and 1.45% on all wages
• The Payroll Tax is the fastest growing source of
federal revenue
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7-37
The Incidence of the Social Security Tax
at Various Income Levels in 1998
Level of Earned Income Taxes Paid
Average Tax Rate
$ 10,000
$ 620.00
6.2%
68,400
4,240,80
6.2%
100,000
4,240.80
4.24%
1,000,000
4,240.80
0.424%
Note: The current social security tax by law is set at 6.2 %
with a wage based limitation of $80,400
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
7-38
The Corporate Income Tax
• The corporate income tax is a tax on a
corporation’s profits
– The maximum rate is 35%
• All corporations earning profits of at
least $335,000 pay an average of tax rate
of 35%
– Loopholes in the tax law allow many
corporations to pay much lower taxes
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
7-39
Excise Taxes
• An excise tax is a sales tax aimed at
specific goods and services
• Most excise taxes are levied by the
federal government
– State and local governments also often levy
taxes on the same items
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7-40
Excise Taxes (Continued)
• Excise taxes tend to reduce consumption
of certain products of which the federal
government takes a dim view (e.g.,
cigarettes)
• Excise taxes are usually regressive
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7-41
The Estate Tax
• The estate tax is a tax on the estates of
people who die
– It is a graduated tax that rises to 55%
• It is levied only on estates valued at $675,000 or
more
– More than 90% of estate taxes are paid by
people with incomes above $200,000 a year
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
7-42
Sources of State and Local Tax
Revenue
• Sales Tax
– Is a source of over half of all taxes collected
by the states
– Is a highly regressive tax
• Property taxes
– Provides 80% of all local tax revenue
– Can distort business decisions about where
to locate
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7-43
The State and Local Fiscal
Dilemma
• Since World War II, state and local
governments have been expected to
provide an increasing number of services
– Most notable are health, welfare, education,
and police protection
– Programs dropped at the Federal level must
often be picked up at the state or local level
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
7-44
The State and Local Fiscal
Dilemma (Continued)
• During the 1960s and 1970s the federal
government helped states with increasing
grants-in-aid and general revenue
sharing
• The Reagan administration not only
stemmed this increase, but strongly
reversed it
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7-45
The State and Local Fiscal
Dilemma (Continued)
• Neighboring states and local
governments are in direct competition
with one another for tax dollars
– If one government’s tax rates rise too far
above the levels of its neighbors, it citizens
will vote with their feet
• The 1998 Internet Tax Freedom Act
declared a three-year moratorium for
online sales
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
7-46
Government Tax Rates as a Percentage of
GDP, 1929 and 2000
35
Total: 30.6%
30
Tax Rates are almost
three times as high as
they were in 1929
State
and
loc al
25
20
15
Total: 11%
10
5
State
and
loc al
Federal
Federal
0
1929
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2000
7-47
Tax Receipts as a Percentage of GDP in the
United States and Selected Western European
Countries, 1999
60
50
40
30
20
10
*Please note: These are 1999 f igures. By 2000, U.S. tax receipts were just 30.6 percent of GDP, and, assuming a major
tax cut in 2001 they may soon f all below 30 percent of GDP.
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
7-48
Two Principles of Taxation: I
• Ability to pay principle
– Ability to pay
• Rich people would pay a much higher proportion of their
incomes than the middle class
• Middle class would pay a higher proportion of their
incomes than the poor
– Is this fair?
• Possibly, but only if you are solely concerned with people’s
incomes
• It also depends on how you define the rich and middle class
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
7-49
Two Principles of Taxation: II
• Benefits received principle
– Some people receive more benefits than
others
– Applying the benefits received principle
strictly could end up with absurd results
– We are not always clear about the value of
any benefits received
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
7-50
Two Principles of Taxation
(Continued)
• An example of the ability to pay principle is the
federal personal income tax
• An example of the benefits received principle is
the federal and state tax on gasoline, which is
geared to the number of miles driven
• A tax based on both principles cannot be
devised because they appear to be mutually
exclusive
– Therefore, some taxes are based on the ability to pay
principle while others are based on the benefits
received principle
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
7-51
The Economic Role of Government
• Provision of Public Goods and Services
• Redistribution of Income
• Stabilization
• Economic Regulation
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7-52
Provision of Public Goods and
Services
• Some examples
–
–
–
–
–
–
–
Defense of the country
Maintenance of internal order
Provision of a nationwide highway network
Provision of a money supply
Provision of public education
Running the criminal justice system
Environmental protection
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7-53
Redistribution of Income
• The government redistributes hundreds of
billions of dollars every year
– Social security redistributes money from those
currently working to those who have retired
– Welfare for the poor
• Examples are food stamps, Medicaid, disability payments
and unemployment benefits
– Welfare for the rich
• Examples are subsidies to corporate farmers and tax
breaks for defense contractors, oil companies, and other
large corporations
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7-54
Stabilization
• Two basic goals of economic stabilization
by the federal government
– Stable prices with little or no inflation
– Low unemployment
• An economic rate of growth high enough to keep
the unemployment rate to a minimum
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7-55
Economic Regulation
• The government provides the economic rules of
the game
– This must be done within the social and political
context in which the economy operates
• The government must allow individuals and business firms
to operate with the maximum degree of freedom
• There is little agreement as to how far economic freedom
may be extended without interfering with society as a
whole or the economic rights of specific individuals or
business firms
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7-56
Adam Smith’s Dos and Don’ts
• Do
– Protect society from the violence and
invasion of other countries
– Establish an exact administration of justice
– Erect and maintain certain public works and
institutions where private enterprise could
not profit from doing so
• Don’t
– Do anything else
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7-57
Conclusion
• Until the 1930s, the federal government
more or less followed the role prescribed
by Adam Smith
• The government’s economic role has
expanded tremendously these last seven
decades
• It will continue to grow in the coming
years
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7-58
Big government, like rock ‘n’ roll, is here to stay
Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
7-59