MACROECONOMICS EXPLORE APPLY by Ayers and Collinge Chapter
MACROECONOMICS: EXPLORE & APPLY by Ayers and Collinge Chapter 11 “Fiscal Policy in Action” © 2004 Prentice Hall Publishing Ayers/Collinge, 1/e 1
Learning Objectives 1. List the major revenue sources in the United States. 2. Distinguish two principles of tax equity, and explain why they conflict. 3. Interpret why the U. S. income tax is structured as it is, and why critics suggest changing it. 4. Show why workers pay more Social Security tax than they see withdrawn on their pay stubs. © 2004 Prentice Hall Publishing Ayers/Collinge, 1/e 2
Learning Objectives 5. Justify the use of consumption taxes, including the value added taxes of Canada and Europe. 6. (E&A) Discuss issues of market efficiency and tax equity as they relate to security cost. © 2004 Prentice Hall Publishing Ayers/Collinge, 1/e 3
11. 1 POLICY IN PRACTICE o “In this world, nothing can be said to be certain, except death and taxes. ” – Benjamin Franklin o Few thing are less popular than taxes, since taxes represent money that is taken from us involuntarily by the government. o On the other hand, we all like to be the recipients of government spending. © 2004 Prentice Hall Publishing Ayers/Collinge, 1/e 4
Policy in Practice Government spending encompasses a variety of programs. § The purchase of goods and services such as highways or national defense. § Regulatory programs like OSHA, Health Administration, or the EPA. © 2004 Prentice Hall Publishing § Transfer payments and other safety-net programs that redistribute income to the needy like welfare, or unemployment payments. Ayers/Collinge, 1/e 5
Federal Spending (in billions) Year Total Expenditures Purchases Transfer Payments Net Interest Grants in Aid to State and Local Govt. 1979 701. 1 415 230. 2 44. 8 66. 3 1980 812 469. 4 275 53. 2 72. 3 1981 923. 7 524. 5 311. 8 71. 6 72. 5 1982 1025. 1 572. 1 348. 5 86. 6 69. 5 1983 1113. 5 613. 1 376. 4 99. 4 71. 6 1984 1192. 1 661. 5 387. 4 120. 7 76. 7 1985 1290. 7 719. 5 414. 2 136. 5 80. 9 1986 1378. 1 769. 1 440. 4 145. 1 87. 6 © 2004 Prentice Hall Publishing Ayers/Collinge, 1/e 6
Federal Spending (continued) Year Total Expenditures Purchases Transfer Payments Net Interest Grants in Aid to State and Local Govt. 1987 1458. 2 813. 6 458 156. 7 83. 9 1988 1532. 7 850. 7 486. 5 168. 3 91. 6 1989 1641. 6 902. 6 529. 6 187. 0 98. 3 1990 1778. 0 965. 7 583. 1 204. 3 111. 4 1991 1879. 7 1015. 2 620. 1 223. 1 131. 6 1992 2046. 9 1047. 4 745. 4 232. 0 149. 1 1993 2130. 5 1072. 1 793. 2 235. 8 162. 6 1994 2196. 7 1102. 3 825. 4 244. 0 174. 5 © 2004 Prentice Hall Publishing Ayers/Collinge, 1/e 7
Federal Spending (continued) Year Total Expenditures Purchases Transfer Payments Net Interest Grants in Aid to State and Local Govt. 1995 2293. 7 1133. 9 869. 9 268. 0 184. 5 1996 2384. 5 1171. 8 916. 0 274. 4 190. 4 1997 2462. 4 1223. 3 945 275. 3 196. 8 1998 2592. 3 1261. 4 965. 9 278. 8 210. 3 1999 2624. 8 1328. 0 1000. 1 263. 8 230. 5 2000 2772. 5 1261. 4 965. 9 278. 8 210. 3 Federal spending has grown rapidly over the last century, especially spending on transfer payments, interest on public debt, and grant-in aid. © 2004 Prentice Hall Publishing Ayers/Collinge, 1/e 8
Marginal Personal Tax Rates for Singles, 2002 • An incremental tax rate on incremental income is know as a marginal tax rate. • Marginal Tax rate= additional taxes owed as a percentage of additional income Tax Rate Taxable Income 10% Up to $6, 000 15% $6, 001 - $27, 000 27% $27, 951 - $67, 700 30% $67, 701 - $141, 250 35% $141, 251 - $307, 050 38. 6% $307, 051 or more © 2004 Prentice Hall Publishing Ayers/Collinge, 1/e 9
Federal Revenue Sources © 2004 Prentice Hall Publishing Ayers/Collinge, 1/e 10
Federal Revenue Expenditures © 2004 Prentice Hall Publishing Ayers/Collinge, 1/e 11
State and Local Government Revenue Sources © 2004 Prentice Hall Publishing Ayers/Collinge, 1/e 12
State and Local Government Expenditures © 2004 Prentice Hall Publishing Ayers/Collinge, 1/e 13
Policy in Practice q When all revenue received by all units of government are added together, the result is that government revenues are over 30% of the value of production. q The average American must work until “tax freedom day” each year - declared to be April 27 th as of 2002, in order to have enough money to pay the federal government. © 2004 Prentice Hall Publishing Ayers/Collinge, 1/e 14
Evaluating Tax Equity 1. The two fundamental principles of tax equity are… 1. The benefits principle states that a fair tax is one that taxes people in proportion to the benefits they receive when government spends the tax revenue. 2. The ability-to-pay principle states that those who can afford to pay more taxes than others should be required to do so. © 2004 Prentice Hall Publishing Ayers/Collinge, 1/e 15
Evaluating Tax Equity 1. The gasoline tax would appear to satisfy the benefit principle of tax equity, because gasoline tax revenues are earmarked for highway construction and repair. 2. The ability-to-pay principle is interpreted to mean that taxes designed for redistributing income should be progressive. 3. A progressive tax collects a higher percentage of high than of low incomes. © 2004 Prentice Hall Publishing Ayers/Collinge, 1/e 16
Evaluating Tax Equity Ø A regressive tax collects a higher percentage of low incomes than of high incomes Ø A proportional tax collects the same percentage of income, no matter what the income is. Ø A flat tax that taxes all income at the same tax rate. © 2004 Prentice Hall Publishing Ayers/Collinge, 1/e 17
Trading off Efficiency and Equity 1. Economic efficiency involves getting the most valuable output from the inputs available. 2. In general an efficient tax would be one that does not change our behavior, nor can it be influenced, or escaped. 3. Taxes cause inefficiency. 1. Tax increases cause some workers to cut back their efforts, and some corporations to cut back on investments. © 2004 Prentice Hall Publishing Ayers/Collinge, 1/e 18
Trading off Efficiency and Equity Ø For an efficient tax, we can turn to the head tax. ØIn short, if you have a head, you pay the tax. ØHead taxes would not be equitable. Ø Government tax laws and spending promote equity through provision of a social safety net. ØThe safety net targets the needy with both cash transfers and in-kind benefits. © 2004 Prentice Hall Publishing Ayers/Collinge, 1/e 19
Trading off Efficiency and Equity ü A trade-off between efficiency and equity pervades our system of tax and spending programs. ü A safety net requires guarantees, but the better the guarantees, the more programs will cost, and the less will be the incentive to work and invest. ü There is no ready answer to the dilemma of choosing between a generous safety net and incentives for economic productivity. © 2004 Prentice Hall Publishing Ayers/Collinge, 1/e 20
11. 2 SOCIAL SECURITY • Social Security is the largest government program, both in terms of taxes collected and spending. • Social Security collects taxes on all payroll income, and allots the proceeds for old age, survivors, and disability insurance (OASDI), and hospitalization insurance (HI). © 2004 Prentice Hall Publishing Ayers/Collinge, 1/e 21
Social Tax Rates over Time Calendar Year OASDI 1937 -49 1. 000 1950 1. 500 1951 -53 1. 500 1954 -56 2. 000 1957 -58 2. 250 1959 2. 500 1960 -61 3. 000 1962 3. 125 1963 -65 3. 625 Figure © 2004 11 -4 Prentice Hall Publishing HI Total Ayers/Collinge, 1/e 22
Social Tax Rates over Time (cont’d. ) Calendar Year OASDI HI Total 1966 3. 850 . 350 4. 200 1967 3. 900 0. 500 4. 400 1968 3. 800 0. 600 4. 400 1969 -70 4. 200 0. 600 4. 800 1971 -72 4. 600 0. 600 5. 200 1973 4. 850 1. 000 5. 850 1974 -77 4. 950 0. 900 5. 850 1978 5. 050 1. 000 6. 050 1979 -80 5. 080 1. 050 6. 130 Figure © 2004 11 -4 Prentice Hall Publishing Ayers/Collinge, 1/e 23
Social Tax Rates over Time (cont’d. ) Calendar Year OASDI HI Total 1981 5. 350 1. 300 6. 650 1982 -83 5. 400 1. 300 6. 700 1984 5. 700 1. 300 7. 000 1985 5. 700 1. 350 7. 050 1986 -87 5. 700 1. 450 7. 150 1988 -89 6. 060 1. 450 7. 510 1990 and later 6. 200 1. 450 7. 650 Figure © 2004 11 -4 Prentice Hall Publishing Ayers/Collinge, 1/e 24
Social Security o The combined employer and employee Social security tax rate is 15. 3% of the first $84, 900 of that income in 2002. o The threshold has been adjusted upward over time in response to wage inflation. o The portion of the social security tax paid by employers reduces their after-tax demand for the labor by the same percentage as the tax. o In effect the tax burden has been shifted from employers to employees. © 2004 Prentice Hall Publishing Ayers/Collinge, 1/e 25
The Effect of Social Security Tax on Wages Economy’ s supply of labor #2 The result is a lower market wage Rate. © 2004 Prentice Hall Publishing #1 The more payroll taxes firms must pay to government, the less wages they are willing to pay to workers. Economy’s demand for labor Fullemployment Labor Ayers/Collinge, 1/e 26
Social Security 1. Social Security is pay-as you-go, meaning that current workers pay for people who are currently retired. 2. In this way, Social Security redistributes income from one generation to another. 3. It is predicted that the number of workers to retirees will drop to only about 2 to 1 by 2030. 4. To keep benefits constant the Social Security administration estimates that the tax rate would need to rise by almost 21% by 2034. © 2004 Prentice Hall Publishing Ayers/Collinge, 1/e 27
Social Security § Social Security also redistributes income within generations. The ratio of payments to retirees to the amount they contributed in their working years is much higher for the low income than for the high income. § Payments are also adjusted on the basis of need, which is determined in part by the number of dependents a person has. § Even though the tax took out the same portion of each person’s income when they were working, the percentage given back is much higher for the poor. © 2004 Prentice Hall Publishing Ayers/Collinge, 1/e 28
Social Security § On an after tax basis, the tax may even pay the retired low-income worker more than he or she earned while working. § The redistribution from higher-income to lowerincome workers is one reason participation in Social Security is required by law. § New investors (workers) are forced into the Social Security system by government and its power to tax. © 2004 Prentice Hall Publishing Ayers/Collinge, 1/e 29
A Trust Fund of IOU’s v The Social Security Trust Fund is the depository for Social Security tax revenues. v All savings in the fund are held in the form of special government bonds. v. The savings in the fund are nothing more than government IOU’s. v In order for the fund to be fully-funded, it would need to well over a year’s worth of GDP. © 2004 Prentice Hall Publishing Ayers/Collinge, 1/e 30
11. 3 TAX REFORM q. Tax reform is a compromise between those who want to pay less, and those who want to receive more. q. Broad-based taxes are efficient because they do not distort relative prices. q. The personal income tax system is a progressive tax system. q. It is based on the ability to pay, and is a compromise between efficiency and equity. © 2004 Prentice Hall Publishing Ayers/Collinge, 1/e 31
Tax Reform q Measuring income is another issue in evaluating income taxes. q. The U. S. income tax code focuses on liquid income. q If a person sells illiquid assets, they are taxed on realized capital gains. q There are loopholes in the tax code. q Two concepts are used to evaluate tax expenditures. q. Vertical equity – based on differing ability to pay. q. Horizontal equity – says that people with equal means should pay equal tax. © 2004 Prentice Hall Publishing Ayers/Collinge, 1/e 32
11. 4 EXPLORE & APPLY Paying for Homeland Security Ø It is expensive to protect the nation against terrorist threats. Ø There a number of ways to finance the new security measures. ØUse general tax revenues. ØLevy taxes on specific industries for which the government provides security. ØLet industries facing the threats absorb the cost. © 2004 Prentice Hall Publishing Ayers/Collinge, 1/e 33
Terms Along the Way • • • transfer payments marginal tax rate tax incidence benefit principle ability-to-pay principle • progressive tax © 2004 Prentice Hall Publishing • • • regressive tax proportional tax in-kind benefits pay-as-you-go Social Security trust fund • fully funded Ayers/Collinge, 1/e 34
Terms Along the Way • Individual Retirement Accounts (IRAs) • Personal Security Accounts • tax base • comprehensive measures of income © 2004 Prentice Hall Publishing • • • tax expenditures vertical equity horizontal equity consumed-income tax consumption tax value-added tax Ayers/Collinge, 1/e 35
Test Yourself 1. An average tax rate is a. additional taxes owed as a percentage of additional income. b. total taxes owed. c. total taxes owed as a percentage of income. d. the percentage of income not collected in taxes. © 2004 Prentice Hall Publishing Ayers/Collinge, 1/e 36
Test Yourself 2. a. b. c. d. A value-added tax is an example of a property tax. Social security tax. income tax. consumption tax. © 2004 Prentice Hall Publishing Ayers/Collinge, 1/e 37
Test Yourself 3. The benefits principles and the abilityto-pay principle refer to a. whether a tax is progressive or regressive. b. principles of tax efficiency. c. principles of tax equity. d. legal principles that question the constitutionality of Social Security. © 2004 Prentice Hall Publishing Ayers/Collinge, 1/e 38
Test Yourself 4. The gasoline tax is a. used to fund various government programs. b. the best example of a progressive tax. c. seems to satisfy the ability-to-pay principle. d. reflects the benefit principle, since those who pay the tax tend to receive benefits. © 2004 Prentice Hall Publishing Ayers/Collinge, 1/e 39
Test Yourself 5. If a tax collects 5 percent of the income of those making less than $100, 000 and 10 percent of the income of those making $100, 000 or more, the tax is a. progressive. b. regressive. c. proportional. d. flat. © 2004 Prentice Hall Publishing Ayers/Collinge, 1/e 40
Test Yourself 6. If a tax collects 10 percent of the income of those making less than $100, 000 and 5 percent of the income of those making $100, 000 or more, the tax is a. a head tax. b. progressive. c. regressive. d. proportional. © 2004 Prentice Hall Publishing Ayers/Collinge, 1/e 41
The End! Next Chapter 12 “Economic Growth" © 2004 Prentice Hall Publishing Ayers/Collinge, 1/e 42
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