©2004 Prentice Hall Publishing Ayers/Collinge, 1/e 1 Chapter 11 “Fiscal Policy in Action”

1 ©2004 Prentice Hall Publishing Ayers/Collinge, 1/e

Chapter 11“Fiscal Policy in Action”

Chapter 11“Fiscal Policy in Action”

ECONOMICS: ECONOMICS: EXPLORE & APPLYEXPLORE & APPLYby Ayers and Collingeby Ayers and Collinge

ECONOMICS: ECONOMICS: EXPLORE & APPLYEXPLORE & APPLYby Ayers and Collingeby Ayers and Collinge


Learning ObjectivesLearning ObjectivesLearning ObjectivesLearning Objectives

1.1. List the major revenue sources in the United List the major revenue sources in the United States.States.

2.2. Distinguish two principles of tax equity, and Distinguish two principles of tax equity, and explain why they conflict.explain why they conflict.

3.3. Interpret why the U.S. income tax is Interpret why the U.S. income tax is structured as it is, and why critics suggest structured as it is, and why critics suggest changing it. changing it.

4.4. Show why workers pay more Social Security Show why workers pay more Social Security tax than they see withdrawn on their pay tax than they see withdrawn on their pay stubs.stubs.

1.1. List the major revenue sources in the United List the major revenue sources in the United States.States.

2.2. Distinguish two principles of tax equity, and Distinguish two principles of tax equity, and explain why they conflict.explain why they conflict.

3.3. Interpret why the U.S. income tax is Interpret why the U.S. income tax is structured as it is, and why critics suggest structured as it is, and why critics suggest changing it. changing it.

4.4. Show why workers pay more Social Security Show why workers pay more Social Security tax than they see withdrawn on their pay tax than they see withdrawn on their pay stubs.stubs.


Learning ObjectivesLearning ObjectivesLearning ObjectivesLearning Objectives

5.5. Justify the use of consumption taxes, Justify the use of consumption taxes, including the value added taxes of Canada including the value added taxes of Canada and Europe.and Europe.

6.6. (E&A) Discuss issues of market efficiency and (E&A) Discuss issues of market efficiency and tax equity as they relate to security cost.tax equity as they relate to security cost.

5.5. Justify the use of consumption taxes, Justify the use of consumption taxes, including the value added taxes of Canada including the value added taxes of Canada and Europe.and Europe.

6.6. (E&A) Discuss issues of market efficiency and (E&A) Discuss issues of market efficiency and tax equity as they relate to security cost.tax equity as they relate to security cost.


11.111.1POLICY IN PRACTICEPOLICY IN PRACTICE11.111.1POLICY IN PRACTICEPOLICY IN PRACTICE

o ““In this world, nothing can be said to be In this world, nothing can be said to be certain, except death and taxes.”certain, except death and taxes.”

– Benjamin FranklinBenjamin Franklin

o Few thing are less popular than Few thing are less popular than taxestaxes, , since taxes represent money that is taken since taxes represent money that is taken from us involuntarily by the government.from us involuntarily by the government.

o On the other hand, we all like to be the On the other hand, we all like to be the recipients of government spending.recipients of government spending.

o ““In this world, nothing can be said to be In this world, nothing can be said to be certain, except death and taxes.”certain, except death and taxes.”

– Benjamin FranklinBenjamin Franklin

o Few thing are less popular than Few thing are less popular than taxestaxes, , since taxes represent money that is taken since taxes represent money that is taken from us involuntarily by the government.from us involuntarily by the government.

o On the other hand, we all like to be the On the other hand, we all like to be the recipients of government spending.recipients of government spending.


The purchase of The purchase of goods and services goods and services such as highways or such as highways or national defense.national defense.

Regulatory Regulatory programs like programs like OSHA, Health OSHA, Health Administration, or Administration, or the EPA.the EPA.

The purchase of The purchase of goods and services goods and services such as highways or such as highways or national defense.national defense.

Regulatory Regulatory programs like programs like OSHA, Health OSHA, Health Administration, or Administration, or the EPA.the EPA.

Transfer paymentsTransfer payments and other and other safety-net safety-net programsprograms that that redistribute income redistribute income to the needy like to the needy like welfare, or welfare, or unemployment unemployment payments.payments.

Transfer paymentsTransfer payments and other and other safety-net safety-net programsprograms that that redistribute income redistribute income to the needy like to the needy like welfare, or welfare, or unemployment unemployment payments.payments.

Policy in PracticePolicy in PracticePolicy in PracticePolicy in Practice

Government spending encompasses a variety of programs.


Federal Spending (in billions)Federal Spending (in billions)Federal Spending (in billions)Federal Spending (in billions)

YearYear TotalTotal

ExpendituresExpenditures

PurchasesPurchases Transfer Transfer PaymentsPayments

NetNet

InterestInterest

Grants in AidGrants in Aid

to State and to State and Local Govt.Local Govt.

19791979 701.1701.1 415415 230.2230.2 44.844.8 66.366.3

19801980 812812 469.4469.4 275275 53.253.2 72.372.3

19811981 923.7923.7 524.5524.5 311.8311.8 71.671.6 72.572.5

19821982 1025.11025.1 572.1572.1 348.5348.5 86.686.6 69.569.5

19831983 1113.51113.5 613.1613.1 376.4376.4 99.499.4 71.671.6

19841984 1192.11192.1 661.5661.5 387.4387.4 120.7120.7 76.776.7

19851985 1290.71290.7 719.5719.5 414.2414.2 136.5136.5 80.980.9

19861986 1378.11378.1 769.1769.1 440.4440.4 145.1145.1 87.687.6


Federal Spending (continued)Federal Spending (continued)Federal Spending (continued)Federal Spending (continued)

YearYear TotalTotal



NetNet

InterestInterest



19871987 1458.21458.2 813.6813.6 458458 156.7156.7 83.983.9

19881988 1532.71532.7 850.7850.7 486.5486.5 168.3168.3 91.691.6

19891989 1641.61641.6 902.6902.6 529.6529.6 187.0187.0 98.398.3

19901990 1778.01778.0 965.7965.7 583.1583.1 204.3204.3 111.4111.4

19911991 1879.71879.7 1015.21015.2 620.1620.1 223.1223.1 131.6131.6

19921992 2046.92046.9 1047.41047.4 745.4745.4 232.0232.0 149.1149.1

19931993 2130.52130.5 1072.11072.1 793.2793.2 235.8235.8 162.6162.6

19941994 2196.72196.7 1102.31102.3 825.4825.4 244.0244.0 174.5174.5


Federal Spending (continued)Federal Spending (continued)Federal Spending (continued)Federal Spending (continued)

YearYear TotalTotal



NetNet

InterestInterest



19951995 2293.72293.7 1133.91133.9 869.9869.9 268.0268.0 184.5184.5

19961996 2384.52384.5 1171.81171.8 916.0916.0 274.4274.4 190.4190.4

19971997 2462.42462.4 1223.31223.3 945945 275.3275.3 196.8196.8

19981998 2592.32592.3 1261.41261.4 965.9965.9 278.8278.8 210.3210.3

19991999 2624.82624.8 1328.01328.0 1000.11000.1 263.8263.8 230.5230.5

20002000 2772.52772.5 1261.41261.4 965.9965.9 278.8278.8 210.3210.3

Federal spending has grown rapidly over the last century, especially spending on transfer payments,

interest on public debt, and grant-in aid.


Marginal Personal Tax Rates for Singles, 2002Marginal Personal Tax Rates for Singles, 2002Marginal Personal Tax Rates for Singles, 2002Marginal Personal Tax Rates for Singles, 2002

•An incremental tax rate on incremental An incremental tax rate on incremental income is know as a income is know as a marginal tax ratemarginal tax rate..•Marginal Tax rate= additional taxes Marginal Tax rate= additional taxes owed as a percentage of additional incomeowed as a percentage of additional income

•An incremental tax rate on incremental An incremental tax rate on incremental income is know as a income is know as a marginal tax ratemarginal tax rate..•Marginal Tax rate= additional taxes Marginal Tax rate= additional taxes owed as a percentage of additional incomeowed as a percentage of additional income

Tax RateTax Rate Taxable IncomeTaxable Income

10%10% Up to $6,000Up to $6,000

15%15% $6,001 - $27,000$6,001 - $27,000

27%27% $27,951 - $67,700$27,951 - $67,700

30%30% $67,701 - $141,250$67,701 - $141,250

35%35% $141,251 - $307,050$141,251 - $307,050

38.6%38.6% $307,051 or more$307,051 or more


Federal Revenue SourcesFederal Revenue SourcesFederal Revenue SourcesFederal Revenue SourcesOther

8% Individual Income taxes

49%

Corporate Income taxes

8%

Social Security

taxes35%

Other8% Individual

Income taxes49%

Corporate Income taxes

8%

Social Security

taxes35%


Federal Revenue ExpendituresFederal Revenue ExpendituresFederal Revenue ExpendituresFederal Revenue Expenditures

Other3%

Grants14% Purchases

27%

Transfer Payments

44%

Net Intererest

12%

Other3%

Grants14% Purchases

27%

Transfer Payments

44%

Net Intererest

12%


State and Local Government State and Local Government Revenue SourcesRevenue Sources

State and Local Government State and Local Government Revenue SourcesRevenue Sources

Corporation net income

taxes3%

Individual Income taxes

23%

Property Taxes19%

Revenue from the Federal

Government22%

Other Taxes and Charges

33%

Corporation net income

taxes3%

Individual Income taxes

23%

Property Taxes19%

Revenue from the Federal

Government22%

Other Taxes and Charges

33%


State and Local Government State and Local Government ExpendituresExpenditures

State and Local Government State and Local Government ExpendituresExpenditures

Public Welfare16%

Highways7%

Education34%Other

43%

Public Welfare16%

Highways7%

Education34%Other

43%


When all revenue received by all units of When all revenue received by all units of government are added together, the result is government are added together, the result is that government revenues are over 30% of the that government revenues are over 30% of the value of production.value of production.

The average American must work until The average American must work until “tax “tax freedom day”freedom day” each year - declared to be April each year - declared to be April 2727thth as of 2002, in order to have enough money as of 2002, in order to have enough money to pay the federal government.to pay the federal government.

When all revenue received by all units of When all revenue received by all units of government are added together, the result is government are added together, the result is that government revenues are over 30% of the that government revenues are over 30% of the value of production.value of production.

The average American must work until The average American must work until “tax “tax freedom day”freedom day” each year - declared to be April each year - declared to be April 2727thth as of 2002, in order to have enough money as of 2002, in order to have enough money to pay the federal government.to pay the federal government.

Policy in PracticePolicy in PracticePolicy in PracticePolicy in Practice


Evaluating Tax EquityEvaluating Tax EquityEvaluating Tax EquityEvaluating Tax Equity

The two fundamental principles of tax The two fundamental principles of tax equity are…equity are…The The benefits principlebenefits principle states that a fair tax is states that a fair tax is

one that taxes people in proportion to the one that taxes people in proportion to the benefits they receive when government benefits they receive when government spends the tax revenue.spends the tax revenue.

The The ability-to-payability-to-pay principle states that those principle states that those who can afford to pay more taxes than who can afford to pay more taxes than others should be required to do so.others should be required to do so.

The two fundamental principles of tax The two fundamental principles of tax equity are…equity are…The The benefits principlebenefits principle states that a fair tax is states that a fair tax is

one that taxes people in proportion to the one that taxes people in proportion to the benefits they receive when government benefits they receive when government spends the tax revenue.spends the tax revenue.

The The ability-to-payability-to-pay principle states that those principle states that those who can afford to pay more taxes than who can afford to pay more taxes than others should be required to do so.others should be required to do so.


The gasoline tax would appear to satisfy the The gasoline tax would appear to satisfy the benefit principle of tax equity, because gasoline benefit principle of tax equity, because gasoline tax revenues are earmarked for highway tax revenues are earmarked for highway construction and repair.construction and repair.

The ability-to-pay principle is interpreted to The ability-to-pay principle is interpreted to mean that taxes designed for redistributing mean that taxes designed for redistributing income should be income should be progressive.progressive.

A progressive tax A progressive tax collects a higher percentage of collects a higher percentage of high than of low incomes. high than of low incomes.

The gasoline tax would appear to satisfy the The gasoline tax would appear to satisfy the benefit principle of tax equity, because gasoline benefit principle of tax equity, because gasoline tax revenues are earmarked for highway tax revenues are earmarked for highway construction and repair.construction and repair.

The ability-to-pay principle is interpreted to The ability-to-pay principle is interpreted to mean that taxes designed for redistributing mean that taxes designed for redistributing income should be income should be progressive.progressive.

A progressive tax A progressive tax collects a higher percentage of collects a higher percentage of high than of low incomes. high than of low incomes.



A A regressive taxregressive tax collects a higher collects a higher percentage of low incomes than of high percentage of low incomes than of high incomesincomes

A A proportional taxproportional tax collects the same collects the same percentage of income, no matter what the percentage of income, no matter what the income is.income is.

A A flat taxflat tax that taxes all income at the that taxes all income at the same tax rate . same tax rate .

A A regressive taxregressive tax collects a higher collects a higher percentage of low incomes than of high percentage of low incomes than of high incomesincomes

A A proportional taxproportional tax collects the same collects the same percentage of income, no matter what the percentage of income, no matter what the income is.income is.

A A flat taxflat tax that taxes all income at the that taxes all income at the same tax rate . same tax rate .



Trading off Efficiency and EquityTrading off Efficiency and Equity Trading off Efficiency and EquityTrading off Efficiency and Equity

Economic efficiency involves getting the most Economic efficiency involves getting the most valuable output from the inputs available.valuable output from the inputs available.

In general an In general an efficient taxefficient tax would be one that would be one that does not change our behavior, nor can it be does not change our behavior, nor can it be influenced, or escaped.influenced, or escaped.

Taxes cause inefficiency.Taxes cause inefficiency. Tax increases cause some workers to cut back their Tax increases cause some workers to cut back their

efforts, and some corporations to cut back on efforts, and some corporations to cut back on investments.investments.

Economic efficiency involves getting the most Economic efficiency involves getting the most valuable output from the inputs available.valuable output from the inputs available.

In general an In general an efficient taxefficient tax would be one that would be one that does not change our behavior, nor can it be does not change our behavior, nor can it be influenced, or escaped.influenced, or escaped.

Taxes cause inefficiency.Taxes cause inefficiency. Tax increases cause some workers to cut back their Tax increases cause some workers to cut back their

efforts, and some corporations to cut back on efforts, and some corporations to cut back on investments.investments.


Trading off Efficiency and EquityTrading off Efficiency and Equity Trading off Efficiency and EquityTrading off Efficiency and Equity

For an efficient tax, we can turn to the For an efficient tax, we can turn to the head tax.head tax.In short, if you have a head, you pay the tax.In short, if you have a head, you pay the tax.Head taxes would not be equitable.Head taxes would not be equitable.

Government tax laws and spending Government tax laws and spending promote equity through provision of a promote equity through provision of a social safety net.social safety net.The safety net targets the needy with both The safety net targets the needy with both

cash transfers and cash transfers and in-kind benefits.in-kind benefits.

For an efficient tax, we can turn to the For an efficient tax, we can turn to the head tax.head tax.In short, if you have a head, you pay the tax.In short, if you have a head, you pay the tax.Head taxes would not be equitable.Head taxes would not be equitable.

Government tax laws and spending Government tax laws and spending promote equity through provision of a promote equity through provision of a social safety net.social safety net.The safety net targets the needy with both The safety net targets the needy with both

cash transfers and cash transfers and in-kind benefits.in-kind benefits.


A trade-off between efficiency and equity A trade-off between efficiency and equity pervades our system of tax and spending pervades our system of tax and spending programs.programs.

A safety net requires guarantees, but the better A safety net requires guarantees, but the better the guarantees, the more programs will cost, the guarantees, the more programs will cost, and the less will be the incentive to work and and the less will be the incentive to work and invest.invest.

There is no ready answer to the dilemma of There is no ready answer to the dilemma of choosing between a generous safety net and choosing between a generous safety net and incentives for economic productivity. incentives for economic productivity.

A trade-off between efficiency and equity A trade-off between efficiency and equity pervades our system of tax and spending pervades our system of tax and spending programs.programs.

A safety net requires guarantees, but the better A safety net requires guarantees, but the better the guarantees, the more programs will cost, the guarantees, the more programs will cost, and the less will be the incentive to work and and the less will be the incentive to work and invest.invest.

There is no ready answer to the dilemma of There is no ready answer to the dilemma of choosing between a generous safety net and choosing between a generous safety net and incentives for economic productivity. incentives for economic productivity.

Trading off Efficiency and EquityTrading off Efficiency and EquityTrading off Efficiency and EquityTrading off Efficiency and Equity


11.2 11.2 SOCIAL SECURITYSOCIAL SECURITY11.2 11.2 SOCIAL SECURITYSOCIAL SECURITY

• Social SecuritySocial Security is the largest government is the largest government program, both in terms of taxes collected program, both in terms of taxes collected and spending.and spending.

• Social Security collects taxes on all Social Security collects taxes on all payroll income, and allots the proceeds payroll income, and allots the proceeds for old age, survivors, and disability for old age, survivors, and disability insurance (OASDI), and hospitalization insurance (OASDI), and hospitalization insurance (HI).insurance (HI).

• Social SecuritySocial Security is the largest government is the largest government program, both in terms of taxes collected program, both in terms of taxes collected and spending.and spending.

• Social Security collects taxes on all Social Security collects taxes on all payroll income, and allots the proceeds payroll income, and allots the proceeds for old age, survivors, and disability for old age, survivors, and disability insurance (OASDI), and hospitalization insurance (OASDI), and hospitalization insurance (HI).insurance (HI).


Social Tax Rates over TimeSocial Tax Rates over TimeSocial Tax Rates over TimeSocial Tax Rates over Time

Calendar YearCalendar Year OASDIOASDI HIHI TotalTotal

1937-491937-49 1.0001.000 1.0001.000

19501950 1.5001.500 1.5001.500

1951-531951-53 1.5001.500 1.5001.500

1954-561954-56 2.0002.000 2.0002.000

1957-581957-58 2.2502.250 2.2502.250

19591959 2.5002.500 2.5002.500

1960-611960-61 3.0003.000 3.0003.000

19621962 3.1253.125 3.1253.125

1963-651963-65 3.6253.625 3.6253.625

Figure 11-4Figure 11-4


Social Tax Rates over Time (cont’d.)Social Tax Rates over Time (cont’d.)Social Tax Rates over Time (cont’d.)Social Tax Rates over Time (cont’d.)


19661966 3.8503.850 .350.350 4.2004.200

19671967 3.9003.900 0.5000.500 4.4004.400

19681968 3.8003.800 0.6000.600 4.4004.400

1969-701969-70 4.2004.200 0.6000.600 4.8004.800

1971-721971-72 4.6004.600 0.6000.600 5.2005.200

19731973 4.8504.850 1.0001.000 5.8505.850

1974-771974-77 4.9504.950 0.9000.900 5.8505.850

19781978 5.0505.050 1.0001.000 6.0506.050

1979-801979-80 5.0805.080 1.0501.050 6.1306.130



Social Tax Rates over Time (cont’d.)Social Tax Rates over Time (cont’d.)Social Tax Rates over Time (cont’d.)Social Tax Rates over Time (cont’d.)


19811981 5.3505.350 1.3001.300 6.6506.650

1982-831982-83 5.4005.400 1.3001.300 6.7006.700

19841984 5.7005.700 1.3001.300 7.0007.000

19851985 5.7005.700 1.3501.350 7.0507.050

1986-871986-87 5.7005.700 1.4501.450 7.1507.150

1988-891988-89 6.0606.060 1.4501.450 7.5107.510

1990 and later1990 and later 6.2006.200 1.4501.450 7.6507.650



Social SecuritySocial SecuritySocial SecuritySocial Security

o The combined employer and employee Social The combined employer and employee Social security tax rate is 15.3% of the first $84,900 of security tax rate is 15.3% of the first $84,900 of that income in 2002.that income in 2002.o The threshold has been adjusted upward over time The threshold has been adjusted upward over time

in response to wage inflation.in response to wage inflation.

o The portion of the social security tax paid by The portion of the social security tax paid by employers reduces their after-tax demand for employers reduces their after-tax demand for the labor by the same percentage as the tax.the labor by the same percentage as the tax.

o In effect the tax burden has been shifted from In effect the tax burden has been shifted from employers to employees.employers to employees.

o The combined employer and employee Social The combined employer and employee Social security tax rate is 15.3% of the first $84,900 of security tax rate is 15.3% of the first $84,900 of that income in 2002.that income in 2002.o The threshold has been adjusted upward over time The threshold has been adjusted upward over time

in response to wage inflation.in response to wage inflation.

o The portion of the social security tax paid by The portion of the social security tax paid by employers reduces their after-tax demand for employers reduces their after-tax demand for the labor by the same percentage as the tax.the labor by the same percentage as the tax.

o In effect the tax burden has been shifted from In effect the tax burden has been shifted from employers to employees.employers to employees.


Economy’ ssupply of labor

Economy’s demandEconomy’s demandfor laborfor labor

LaborFull-employment

#1 The more payroll taxes firms#1 The more payroll taxes firmsmust pay to government, themust pay to government, theless wages they are willing toless wages they are willing topay to workers.pay to workers.

#2 The #2 The resultresultis a loweris a lowermarket market wagewageRate.Rate.

The Effect of Social Security Tax on The Effect of Social Security Tax on WagesWages


Social Security is pay-as you-go, meaning that Social Security is pay-as you-go, meaning that current workers pay for people who are current workers pay for people who are currently retired.currently retired.

In this way, Social Security redistributes In this way, Social Security redistributes income from one generation to another.income from one generation to another.

It is predicted that the number of workers to It is predicted that the number of workers to retirees will drop to only about 2 to 1 by 2030.retirees will drop to only about 2 to 1 by 2030.

To keep benefits constant the Social Security To keep benefits constant the Social Security administration estimates that the tax rate administration estimates that the tax rate would need to rise by almost 21% by 2034.would need to rise by almost 21% by 2034.

Social Security is pay-as you-go, meaning that Social Security is pay-as you-go, meaning that current workers pay for people who are current workers pay for people who are currently retired.currently retired.

In this way, Social Security redistributes In this way, Social Security redistributes income from one generation to another.income from one generation to another.

It is predicted that the number of workers to It is predicted that the number of workers to retirees will drop to only about 2 to 1 by 2030.retirees will drop to only about 2 to 1 by 2030.

To keep benefits constant the Social Security To keep benefits constant the Social Security administration estimates that the tax rate administration estimates that the tax rate would need to rise by almost 21% by 2034.would need to rise by almost 21% by 2034.



Social Security also redistributes income within Social Security also redistributes income within generations. The ratio of payments to retirees to the generations. The ratio of payments to retirees to the amount they contributed in their working years is amount they contributed in their working years is much higher for the low income than for the high much higher for the low income than for the high income.income.

Payments are also adjusted on the basis of need, Payments are also adjusted on the basis of need, which is determined in part by the number of which is determined in part by the number of dependents a person has.dependents a person has.

Even though the tax took out the same portion of Even though the tax took out the same portion of each person’s income when they were working, the each person’s income when they were working, the percentage given back is much higher for the poor.percentage given back is much higher for the poor.

Social Security also redistributes income within Social Security also redistributes income within generations. The ratio of payments to retirees to the generations. The ratio of payments to retirees to the amount they contributed in their working years is amount they contributed in their working years is much higher for the low income than for the high much higher for the low income than for the high income.income.

Payments are also adjusted on the basis of need, Payments are also adjusted on the basis of need, which is determined in part by the number of which is determined in part by the number of dependents a person has.dependents a person has.

Even though the tax took out the same portion of Even though the tax took out the same portion of each person’s income when they were working, the each person’s income when they were working, the percentage given back is much higher for the poor.percentage given back is much higher for the poor.



On an after tax basis, the tax may even pay the On an after tax basis, the tax may even pay the retired low-income worker more than he or she retired low-income worker more than he or she earned while working.earned while working.

The redistribution from higher-income to lower-The redistribution from higher-income to lower-income workers is one reason participation in income workers is one reason participation in Social Security is required by law.Social Security is required by law.

New investors (workers) are forced into the Social New investors (workers) are forced into the Social Security system by government and its power to Security system by government and its power to tax.tax.

On an after tax basis, the tax may even pay the On an after tax basis, the tax may even pay the retired low-income worker more than he or she retired low-income worker more than he or she earned while working.earned while working.

The redistribution from higher-income to lower-The redistribution from higher-income to lower-income workers is one reason participation in income workers is one reason participation in Social Security is required by law.Social Security is required by law.

New investors (workers) are forced into the Social New investors (workers) are forced into the Social Security system by government and its power to Security system by government and its power to tax.tax.



A Trust Fund of IOU’sA Trust Fund of IOU’sA Trust Fund of IOU’sA Trust Fund of IOU’s

The The Social Security Trust FundSocial Security Trust Fund is the is the depository for Social Security tax revenues.depository for Social Security tax revenues.

All savings in the fund are held in the form of All savings in the fund are held in the form of special government bonds.special government bonds.The savings in the fund are nothing more than The savings in the fund are nothing more than

government IOU’s.government IOU’s.

In order for the fund to be fully-funded, it In order for the fund to be fully-funded, it would need to well over a year’s worth of GDP.would need to well over a year’s worth of GDP.

The The Social Security Trust FundSocial Security Trust Fund is the is the depository for Social Security tax revenues.depository for Social Security tax revenues.

All savings in the fund are held in the form of All savings in the fund are held in the form of special government bonds.special government bonds.The savings in the fund are nothing more than The savings in the fund are nothing more than

government IOU’s.government IOU’s.

In order for the fund to be fully-funded, it In order for the fund to be fully-funded, it would need to well over a year’s worth of GDP.would need to well over a year’s worth of GDP.


11.311.3TAX REFORMTAX REFORM11.311.3TAX REFORMTAX REFORMTax reformTax reform is a compromise between is a compromise between

those who want to pay less, and those those who want to pay less, and those who want to receive more.who want to receive more.

Broad-based taxesBroad-based taxes are efficient because are efficient because they do not distort relative prices.they do not distort relative prices.

The personal income tax system is a The personal income tax system is a progressive tax system.progressive tax system.It is based on the ability to pay, and is a It is based on the ability to pay, and is a

compromise between efficiency and equity.compromise between efficiency and equity.

Tax reformTax reform is a compromise between is a compromise between those who want to pay less, and those those who want to pay less, and those who want to receive more.who want to receive more.

Broad-based taxesBroad-based taxes are efficient because are efficient because they do not distort relative prices.they do not distort relative prices.

The personal income tax system is a The personal income tax system is a progressive tax system.progressive tax system.It is based on the ability to pay, and is a It is based on the ability to pay, and is a

compromise between efficiency and equity.compromise between efficiency and equity.


Tax ReformTax ReformTax ReformTax Reform

Measuring income is another issue in Measuring income is another issue in evaluating income taxes.evaluating income taxes.The U.S. income tax code focuses on liquid income.The U.S. income tax code focuses on liquid income.

If a person sells illiquid assets, they are taxed If a person sells illiquid assets, they are taxed on on realized capital gains.realized capital gains.

There are There are loopholesloopholes in the tax code. in the tax code.Two concepts are used to evaluate tax Two concepts are used to evaluate tax

expenditures.expenditures.Vertical equityVertical equity – based on differing ability to pay. – based on differing ability to pay.Horizontal equityHorizontal equity – says that people with equal – says that people with equal

means should pay equal tax.means should pay equal tax.

Measuring income is another issue in Measuring income is another issue in evaluating income taxes.evaluating income taxes.The U.S. income tax code focuses on liquid income.The U.S. income tax code focuses on liquid income.

If a person sells illiquid assets, they are taxed If a person sells illiquid assets, they are taxed on on realized capital gains.realized capital gains.

There are There are loopholesloopholes in the tax code. in the tax code.Two concepts are used to evaluate tax Two concepts are used to evaluate tax

expenditures.expenditures.Vertical equityVertical equity – based on differing ability to pay. – based on differing ability to pay.Horizontal equityHorizontal equity – says that people with equal – says that people with equal

means should pay equal tax.means should pay equal tax.


11.4 EXPLORE & APPLY11.4 EXPLORE & APPLYPaying for Homeland SecurityPaying for Homeland Security11.4 EXPLORE & APPLY11.4 EXPLORE & APPLYPaying for Homeland SecurityPaying for Homeland Security

It is expensive to protect the nation It is expensive to protect the nation against terrorist threats. against terrorist threats.

There are a number of ways to finance There are a number of ways to finance the new security measures.the new security measures.Use general tax revenues.Use general tax revenues.Levy taxes on specific industries for which Levy taxes on specific industries for which

the government provides security.the government provides security.Let industries facing the threats absorb the Let industries facing the threats absorb the

cost.cost.

It is expensive to protect the nation It is expensive to protect the nation against terrorist threats. against terrorist threats.

There are a number of ways to finance There are a number of ways to finance the new security measures.the new security measures.Use general tax revenues.Use general tax revenues.Levy taxes on specific industries for which Levy taxes on specific industries for which

the government provides security.the government provides security.Let industries facing the threats absorb the Let industries facing the threats absorb the

cost.cost.


Terms Along the WayTerms Along the WayTerms Along the WayTerms Along the Way

• transfer paymentstransfer payments• marginal tax ratemarginal tax rate• tax incidencetax incidence• benefit principlebenefit principle• ability-to-pay ability-to-pay

principleprinciple• progressive taxprogressive tax

• transfer paymentstransfer payments• marginal tax ratemarginal tax rate• tax incidencetax incidence• benefit principlebenefit principle• ability-to-pay ability-to-pay

principleprinciple• progressive taxprogressive tax

• regressive taxregressive tax• proportional taxproportional tax• in-kind benefitsin-kind benefits• pay-as-you-gopay-as-you-go• Social Security trust Social Security trust

fundfund• fully fundedfully funded

• regressive taxregressive tax• proportional taxproportional tax• in-kind benefitsin-kind benefits• pay-as-you-gopay-as-you-go• Social Security trust Social Security trust

fundfund• fully fundedfully funded


Terms Along the WayTerms Along the WayTerms Along the WayTerms Along the Way

• Individual Individual Retirement Accounts Retirement Accounts (IRAs)(IRAs)

• Personal Security Personal Security AccountsAccounts

• tax basetax base• comprehensive comprehensive

measures of incomemeasures of income

• Individual Individual Retirement Accounts Retirement Accounts (IRAs)(IRAs)

• Personal Security Personal Security AccountsAccounts

• tax basetax base• comprehensive comprehensive

measures of incomemeasures of income

• tax expenditures tax expenditures • vertical equityvertical equity• horizontal equityhorizontal equity• consumed-income consumed-income

taxtax• consumption taxconsumption tax• value-added taxvalue-added tax

• tax expenditures tax expenditures • vertical equityvertical equity• horizontal equityhorizontal equity• consumed-income consumed-income

taxtax• consumption taxconsumption tax• value-added taxvalue-added tax


Test YourselfTest YourselfTest YourselfTest Yourself

1.1. An average tax rate isAn average tax rate isa.a. additional taxes owed as a percentage of additional taxes owed as a percentage of

additional income.additional income.b.b. total taxes owed.total taxes owed.c.c. total taxes owed as a percentage of total taxes owed as a percentage of

income.income.d.d. the percentage of income not collected in the percentage of income not collected in

taxes.taxes.

1.1. An average tax rate isAn average tax rate isa.a. additional taxes owed as a percentage of additional taxes owed as a percentage of

additional income.additional income.b.b. total taxes owed.total taxes owed.c.c. total taxes owed as a percentage of total taxes owed as a percentage of

income.income.d.d. the percentage of income not collected in the percentage of income not collected in

taxes.taxes.



2.2. A value-added tax is an example of a A value-added tax is an example of a

a.a. property tax.property tax.

b.b. Social security tax.Social security tax.

c.c. income tax.income tax.

d.d. consumption tax.consumption tax.

2.2. A value-added tax is an example of a A value-added tax is an example of a

a.a. property tax.property tax.

b.b. Social security tax.Social security tax.

c.c. income tax.income tax.

d.d. consumption tax.consumption tax.



3.3. The benefits principles and the ability-The benefits principles and the ability-to-pay principle refer toto-pay principle refer to

a.a. whether a tax is progressive or whether a tax is progressive or regressive.regressive.

b.b. principles of tax efficiency.principles of tax efficiency.c.c. principles of tax equity.principles of tax equity.d.d. legal principles that question the legal principles that question the

constitutionality of Social Security.constitutionality of Social Security.

3.3. The benefits principles and the ability-The benefits principles and the ability-to-pay principle refer toto-pay principle refer to

a.a. whether a tax is progressive or whether a tax is progressive or regressive.regressive.

b.b. principles of tax efficiency.principles of tax efficiency.c.c. principles of tax equity.principles of tax equity.d.d. legal principles that question the legal principles that question the

constitutionality of Social Security.constitutionality of Social Security.



4.4. The gasoline tax is The gasoline tax is a.a. used to fund various government used to fund various government

programs.programs.b.b. the best example of a progressive tax.the best example of a progressive tax.c.c. seems to satisfy the ability-to-pay seems to satisfy the ability-to-pay

principle.principle.d.d. reflects the benefit principle, since those reflects the benefit principle, since those

who pay the tax tend to receive benefits.who pay the tax tend to receive benefits.

4.4. The gasoline tax is The gasoline tax is a.a. used to fund various government used to fund various government

programs.programs.b.b. the best example of a progressive tax.the best example of a progressive tax.c.c. seems to satisfy the ability-to-pay seems to satisfy the ability-to-pay

principle.principle.d.d. reflects the benefit principle, since those reflects the benefit principle, since those

who pay the tax tend to receive benefits.who pay the tax tend to receive benefits.



5.5. If a tax collects 5 percent of the income If a tax collects 5 percent of the income of those making less than $100,000 and of those making less than $100,000 and 10 percent of the income of those 10 percent of the income of those making $100,000 or more, the the tax ismaking $100,000 or more, the the tax is

a.a. progressive.progressive.b.b. regressive.regressive.c.c. proportional.proportional.d.d. flat.flat.

5.5. If a tax collects 5 percent of the income If a tax collects 5 percent of the income of those making less than $100,000 and of those making less than $100,000 and 10 percent of the income of those 10 percent of the income of those making $100,000 or more, the the tax ismaking $100,000 or more, the the tax is

a.a. progressive.progressive.b.b. regressive.regressive.c.c. proportional.proportional.d.d. flat.flat.



6.6. If a tax collects 10 percent of the income of If a tax collects 10 percent of the income of those making less than $100,000 and 5 those making less than $100,000 and 5 percent of the income of those making percent of the income of those making $100,000 or more, the the tax is$100,000 or more, the the tax is

a.a. a head tax.a head tax.

b.b. progressive.progressive.

c.c. regressive.regressive.

d.d. proportional.proportional.

6.6. If a tax collects 10 percent of the income of If a tax collects 10 percent of the income of those making less than $100,000 and 5 those making less than $100,000 and 5 percent of the income of those making percent of the income of those making $100,000 or more, the the tax is$100,000 or more, the the tax is

a.a. a head tax.a head tax.

b.b. progressive.progressive.

c.c. regressive.regressive.

d.d. proportional.proportional.


The End!The End!Next Chapter 12Next Chapter 12

““Economic Growth"Economic Growth"

©2004 Prentice Hall Publishing Ayers/Collinge, 1/e 1 Chapter 11 “Fiscal Policy in Action”

Documents

Transcript of ©2004 Prentice Hall Publishing Ayers/Collinge, 1/e 1 Chapter 11 “Fiscal Policy in Action”