Chapter 14 Presentation - Economics - Government Revenue and Spending - PDF

Economics Chapter 14 Government Revenue and Spending Section 1 How Taxes Work What is a tax? ◈ A tax is a mandatory payment to a government; all levels of government, local, state, and/or national government. ◈ Tax money is spent by the government to provide aid to the people. ◈ The rights...

Economics Chapter 14 Government Revenue and Spending Section 1 How Taxes Work What is a tax? ◈ A tax is a mandatory payment to a government; all levels of government, local, state, and/or national government. ◈ Tax money is spent by the government to provide aid to the people. ◈ The rights of the government to tax are set down in the U.S. Constitution and in the state constitutions. What is revenue? ◈ Revenue is government income from taxes and other nontax sources. Nontax sources include borrowing and lotteries. Principles to Evaluate a Tax Benefits-Received Principle ◈ The benefits-received principle of taxation holds that people who benefit directly from public goods should pay for them in proportion to the amount of benefits received. Example: The principle of financing road construction and maintenance through taxes on gasoline. ◈ However, it is difficult for governments to assess exactly how much different taxpayers benefit from services like national defense, national parks, local police and fire protection, and public education. Principles to Evaluate a Tax Ability-to-Pay Principle ◈ The ability-to-pay principle of taxation holds that people should be taxed on their ability to pay, no matter the level of benefits they receive. ◈ According to this principle, people with higher incomes will pay more than people with lower incomes. ◈ The level of benefit received is not a consideration. Tax Systems Criteria for Taxation Equity ◈ The equity, or fairness, of a tax is established by how uniformly the tax is applied. ◈ Equity requires that people in similar situations pay a similar amount of taxes. Example: Everyone who buys gasoline pays the same tax, or all people with the same level of income pay the same amount of taxes. ◈ In addition, some believe that equity requires that people with higher incomes pay more than people with lower incomes. Tax Systems Criteria for Taxation Simplicity ◈ The simplicity of a tax is determined by how easy it is for the taxpayer to understand and how easy it is for the government to collect. ◈ In addition, there should be no confusion about the time the tax is due and the amount to be paid. Example: The sales tax meets the criterion for simplicity. Tax Systems Criteria for Taxation Efficiency ◈ The efficiency of a tax can be judged by how well the tax achieves the goal of raising revenue for the government with the least cost in terms of administration. ◈ From the taxpayers’ viewpoint, tax efficiency can be judged by the amount of effort and expense it takes to pay the tax. Example: The individual income tax best meets the criterion of efficiency. Define tax base. ◈ Each type of wealth subject to taxes is called a tax base, a form of wealth – such as income, property, goods, or services – that is subject to taxes. Common Taxes Individual Income Tax ◈ Individual income tax is based on an individual’s income from all sources – wages, interest, dividends, and tips. ◈ Using income as a tax base means the amount of tax is directly linked to a person’s earnings. Common Taxes Corporate Income Tax ◈ Corporate income tax is based on a corporation’s profits. Common Taxes Sales Tax ◈ Sales tax is based on the value of goods or services at the same time of sale. ◈ Generally, sales taxes are imposed on a wide range of goods and services. ◈ The tax is usually a percentage of the posted price of the good or service and is included in the final price that the buyer pays. ◈ The seller then passes the tax revenue collected from customers on to the government that has imposed the tax. Common Taxes Property Tax ◈ Property tax is based on the value of an individual’s or a business’s assets; generally real estate, automobiles, etc. Tax Structures Proportional Tax ◈ A proportional tax takes the same percentage of income from all taxpayers. Also known as a flat tax. ◈ In the United States, some state and local governments have proportional taxes on individual income. ◈ States with flat taxes generally charge rates from three to five percent of income; cities and counties with proportional taxes charge about one to three percent of income. Tax Structures Progressive Tax ◈ A progressive tax places a higher percentage rate of taxation on high-income people. ◈ In the United States, the federal income tax is a progressive tax, because the tax rate increases as income increases; most states have progressive income taxes, state tax rates range from under one percent to over ten percent. Tax Structures Regressive Tax ◈ A regressive tax takes a larger percentage of income from people with low income than from people with high incomes. Example: Some taxes are regressive because they are applied to sales, not income; although a sales-tax rate is applied equally to all items subject to the tax, the tax as a percentage as a percentage of income is regressive. For similar reasons, property taxes on homes are also considered regressive, low-income homeowners usually spend a higher percentage of their income on housing. Economic Impact of Taxation Resource Allocation ◈ A tax placed on a good or service will increase the costs of production and therefore shift the supply curve to the left; if the demand remains the same, the price of the good or service will go up. This shift will likely result in a shift in resources. ◈ If a supplier is not able to pass increased costs along to the consumer in the form of higher prices, the supplier may choose to shift production to another good that will be more profitable. Example: If the government imposed a 10 percent tax on luxury yachts, which have elastic demand, the producer of the yachts would not be able to raise process enough to cover the full cost of the tax. If it were no longer profitable to sell the yachts because of the extra cost of the tax, the producer might decide to shift resources to producing small fishing boats or go into a different business. Economic Impact of Taxation Productivity and Growth ◈ When taxes on interest and dividends are high, people tend to save less than when taxes on this source of income are low. Therefore, taxes also have an impact on the amount of money available to producers to invest in their businesses. ◈ Some economists also believe that high taxes reduce incentives to work; they suggest that people may spend more time on activities other than work if a large percentage of their income goes to taxes. ◈ Other economists suggest that the underground economy is a result of high taxes; the underground economy refers to jobs, services, and business transactions conducted by word of mouth and, for the most part, paid for in cash to avoid paying taxes. Example: Bob has a part-time landscaping business. He works on the weekends, charges lower prices than larger landscaping companies, and insists that his customers pay him cash. Since there are no records of Bob’s business transactions, it is difficult for the Economic Impact of Taxation Economic Behavior (Tax Incentive) ◈ A tax incentive is the use of taxes to influence economic behavior; by providing tax credits or rebates, the government may encourage behavior that it believes is good for the economy and for society. Example: The government may give tax rebates to businesses for opening new factories, offices, and stores in economically depressed areas. Or government may give tax credits to consumers for activities such as recycling or using energy more efficiently. The positive tax incentive with the widest impact is perhaps the home mortgage interest deduction, which is designed to encourage home ownership. ◈ So-called sin taxes are often imposed on products or activities considered to be unhealthful or damaging to society, such as gambling, alcohol, and cigarettes; these taxes are generally levied on products or activities for which there is relatively inelastic demand. Example: Cigarette sales in Washington fell by nearly 19 percent in the year after the state imposed a 60-cents-per-pack tax increase in 2002. Even so, since the tax increase was so large, cigarette tax revenues went up by more than 40 percent. Section 2 Federal Taxes Where does the federal government’s trillions of dollars in revenue come from every year? ◈ This money comes from several sources, including individual income tax, social insurance taxes, corporate income taxes, estate taxes, gift taxes, excise taxes, and customs taxes. ◈ The largest source of taxes for the federal government is the individual income tax. Paying Your Income Taxes Withholding ◈ If a taxpayer had to pay their income taxes in one lump sum at the end of the year, some people would have difficulty coming up with all the money at once. ◈ To make it easier for taxpayers and the government, a payroll tax – a tax that is taken from a worker’s paycheck – is collected. ◈ The tax that is deducted from a paycheck as withholding, or the money taken from pay before the worker receives it. Paying Your Income Taxes Taxable Income ◈ The amount of tax owed by a person is based on taxable income, the portion of income subject to taxation. ◈ Under federal income tax laws, taxpayers may make certain exemptions and deductions from their total earned income to reduce the amount of their taxable income. Example: Exemptions are allowed for each individual adult and child, so larger families reduce their taxable income by a greater amount than do smaller families. In addition, taxpayers may take a standard deduction or itemize deductions, such as interest paid on a home mortgage, state and local taxes, charitable contributions, and a certain portion of medical expenses. Paying Your Income Taxes Tax Return ◈ Each year, taxpayers must complete a tax return, a form used to report income and taxes owed to the government. ◈ The federal tax return shows how much income has been earned, the exemptions being claimed, and how much tax has been paid through withholding. State and local tax returns show similar, but less detailed information. ◈ Taxpayers who have too much tax withheld receive a refund for overpayment; taxpayers who have not had enough withheld must then pay any additional taxes owed directly to the Internal Revenue Service (IRS) or to state or local departments. Paying Your Income Taxes Federal Insurance Contributions Act (FICA) ◈ FICA is the Federal Insurance Contributions Act, a payroll tax that provides coverage for the elderly, the unemployed due to disability, and surviving family members of wage earners who have dies; also known as social insurance. ◈ Both employees and employers make payments into FICA accounts. FICA Encompasses Several Means of Social Insurance Social Security ◈ Social Security is a federal program to aid older citizens, children who have lost a parent, and the disabled. ◈ The employers and employee each pay 6.2 percent of the employee’s income up to an annual maximum. FICA Encompasses Several Means of Social Insurance Medicare ◈ Medicare is a national health insurance program mainly for citizens over 65 and certain other groups of people. ◈ Employers and employees each pay 1.45 percent of employee income; there is no limit on the amount of income subject to the tax for Medicare. FICA Encompasses Several Means of Social Insurance Unemployment ◈ Unemployment compensation is a program funded by federal and state taxes and administered by the states. ◈ It provides benefits for a certain period of time to employees who lose their jobs through no fault of their own. ◈ Unemployment tax applies to the first $7,000 earned by an employee and, for the most part, is paid only by employers. What is an estate tax? ◈ The estate tax is a tax on property transferred to others on the death of the owner. ◈ Most estates are not subject to this tax, because the government only taxes large estates. ◈ In 2006, estates valued at less than $2 million were not subject to this tax. What is a gift tax? ◈ The gift tax is a tax on assets given by one living person to another. ◈ For the most part, there are exemptions to the gifts that are subject to the tax. ◈ For the most part, these exemptions allow family members to give money to other family members tax-free. What is an excise tax? ◈ The excise tax is a tax on the production or sale of a specific good or service. ◈ In general, the government places excise taxes on goods or services for which there is relatively inelastic demand in order to maintain a steady stream of revenue. What is a customs duty? ◈ The customs duty is a tax on goods imported into the United States. ◈ Customs duties are basically excise taxes on imports and are also known as tariffs. What is a user fee? ◈ A user fee is money charged for the use of a good or service. ◈ These fees are based on the benefits-received principle of taxation. Example: The federal government charges entrance, parking, and camping fees to visitors to national parks; so the people enjoying the parks the most pay for the benefits provided by the parks. Section 3 Federal Government Spending Programs and Services the Federal Government Funds with Revenue Mandatory Spending ◈ Mandatory spending is spending that is required by law. Mandatory spending makes up well over half of all federal spending. ◈ Most of mandatory spending is in the form of entitlements, which are social welfare programs with specific requirements. Social Security ◈ The Social Security program takes the largest amount of federal spending. It provides benefits to older retired workers, disabled workers with limited incomes, and survivors of workers who have died. Social Security is financed through a payroll tax. Therefore, workers must have worked for a certain period of time before they are eligible to receive full benefits under the program. Medicare ◈ The Medicare program was introduced in 1966 as an additional old-age benefit under Social Security. Originally, Medicare provided hospital insurance, funded by a payroll tax, for people over 65, as well as optional medical coverage for items such as doctor bills. This part of Medicare is funded by premiums paid by those choosing the coverage and by general tax revenues. Medicaid ◈ Medicaid is a government medical insurance program for low-income people. The federal government funds about 63 percent of the costs of the program, and the states pay about 37 percent. Other Programs and Services the Federal Government Funds with Revenue Discretionary Spending ◈ ◈ Discretionary spending is spending that the government must authorize each year. More than one-third of federal revenue is devoted to discretionary spending; the programs covered fall into several different categories: Interstate highway system and transportation programs Natural resources and the environment, including conservation programs, pollution clean-up, and national parks Education, most notably college assistance programs Science, space, technology, and other research programs Justice administration, including enforcement agencies, such as the Federal Bureau of Investigation (FBI), and the federal court system What is the federal budget? How is it established? ◈ Each year the President and Congress work together to establish the federal budget, a plan for spending federal tax money. ◈ The budget is prepared for a fiscal year, a 12-month period for which an organization plans its expenditures. The federal government’s fiscal year runs from October 1 through September 30. ◈ The President’s budget is prepared by the Office of Management and Budget (OMB) and takes into account estimated tax receipts and requests by all federal departments and agencies. ◈ The Congressional Budget Office helps the House and Senate develop guidelines for different appropriations, which are specific amounts of money set aside for specific purposes. How are funds from the federal budget spent? ◈ One way is direct spending, by which the government buys goods and services that it needs to operate, such as military equipment and office supplies, and paying the salaries of government employees. ◈ A second way the government spends money is through transfer payments – money distributed to individuals who do not provide anything in return. ◈ A grant-in-aid is a transfer payment from the federal government to state or local governments; these grants are designated for specific categories of activities such as highway construction, certain school services, or Medicaid funding. ◈ How does the federal government influence the economy? Resource Allocation The federal government makes choices concerning where to spend money and what to spend it, and that influences how resources are allocated. Example: If money goes to urban transit, it cannot go to fix rural roads. Similarly, money spent on weapons systems for the military cannot be spent on some other programs, such as environmental protection. How does the federal government influence the economy? Income Redistribution ◈ Government spending affects the incomes of families, individuals, and businesses. ◈ Transfer payments for health care, retirement, and Food Stamp benefits, for example, provide income support for many low-income earners. ◈ How the government awards work contracts can also influence the distribution of income. Example: If the government awards a contract to build several submarines to a shipyard in the Northeast, workers there will be assured work and an income. However, workers at a California shipyard that failed to get the contract may lose their jobs. In turn, they will not have income to spend at local businesses. How does the federal government influence the economy? Competition with the Private Sector ◈ The private sector is the part of the economy owned by individuals or businesses. ◈ The government may produce goods or services that are also produced in the private sector. Examples include veterans’ hospitals that competes with privately owned hospitals, of federal housing that competes with homes and apartments provided by private developers and landlords. Section 4 State and Local Taxes and Spending Where do state revenues come from? ◈ State revenues come from a variety of sources, the largest of which is intergovernmental revenue, mostly grants-in-aid from the federal government; states also raise funds from state sales taxes and from state income tax, both on individuals and on corporations. ◈ Sales taxes All states except Alaska, Delaware, New Hampshire, Montana, and Oregon levy a state sales tax; rates range from 2.9 percent in Colorado to 7.25 percent in California. These taxes generally are applied to most goods and services sold within the state. ◈ Excise taxes All states also have excise taxes on cigarettes, alcohol, gasoline, and diesel fuel; many states also have special sales taxes that mostly affect tourists. ◈ Income taxes and corporate income taxes Most states levy taxes on both individual and corporate income; however, Alaska, Florida, South Dakota, Texas, and Washington have no individual income tax, and Nevada and Wyoming levy neither individual nor corporate income taxes. Most states charge a flat tax rate on corporate income; corporate income tax rates range from one percent to twelve percent. Many state governments structure their corporate tax rates to attract businesses to the state. ◈ Other taxes States also raise revenue from several other sources. Many of these sources, including estate taxes and user fees, are the same as those used by the federal government. Most states also levy property taxes. In addition, most states charge several fees related to businesses and license fees for doctors, dentists, lawyers, and accountants. What is a balanced budget? ◈ All states, except Vermont, are required to have a balanced budget, in which total government revenue from all sources is equal to total government spending. ◈ However, balanced-budget requirements usually apply only to certain kinds of spending. ◈ Further, nearly every state has a reserve fund or may run a surplus, both of which can be used to balance the budget in subsequent years. Types of State Budgets Operating Budget ◈ An operating budget is a plan for day-to-day expenses. ◈ The operating budget generally covers expenses that occur each year, such as salaries for state government employees, payments for health and welfare benefits, and funds for education systems. ◈ Usually, operating budgets are subject to balance-budget requirements. Types of State Budgets Capital Budget ◈ A capital budget is a plan for major expenses or investments. ◈ Capital budgets provide funds for large construction and maintenance projects on state buildings, roads, and bridges, as well as for land acquisition for state construction needs or state parks. ◈ Capital budgets are not subject to the balanced budget because they are usually funded through borrowing; in fact, capital budgets often are run at a deficit, meaning that more is spent than is collected in revenues.