Presentation on theme: "Funding the Public Sector"— Presentation transcript:
1 Funding the Public Sector ECON 151 – PRINCIPLES OF MACROECONOMICSChapter 6:Funding the Public SectorMaterials include content from Pearson Addison-Wesley which has been modified by the instructor and displayed with permission of the publisher. All rights reserved.
2 Paying for the Public Sector Three sources of government fundingFees, or user chargesTaxesBorrowing
3 Paying for the Public Sector (cont'd) Government Budget ConstraintThe limit on government spending and transfer paymentsImposed by the fact that every dollar spent must be provided for by taxes now or in the future to repay debt(Government spending+ transfers) = (Taxes and user charges) + (Government borrowings)
4 Systems of Taxation Tax Base Tax Rate The value of goods, services, wealth, or incomes subject to taxationTax RateThe proportion of a tax base that must be paid to a government as taxes
5 Systems of Taxation (cont'd) Marginal Tax RateThe change in the tax payment divided by the change in incomeMarginal tax rate =Change in taxes dueChange in taxable income
6 Systems of Taxation (cont'd) Tax BracketA specified interval of income to which a specific and unique marginal tax rate is appliedAverage Tax RateThe total tax payment divided by total income
7 Systems of Taxation (cont'd) Proportional TaxationA tax system in which, regardless of an individual’s income, the tax bill comprises exactly the same proportion
14 The Most Important Federal Taxes The federal personal income taxAccounts for about 43.6% of all federal revenueAll U.S. citizens, resident aliens, and most others required to pay (includes income earned abroad)Rates paid rise as income increases
16 The Most Important Federal Taxes (cont'd) Arguments for the progressive taxRedistribution of incomeAbility to payBenefits receivedCounterargumentNo strong evidence of redistributionMay deter investmentPunishes productive behavior
17 The Most Important Federal Taxes (cont'd) Capital GainThe positive difference between the purchase price and the sale price of an assetYou buy a share of stock for $5 and sell for $15: you have a capital gain of $10.Capital LossThe negative difference between the purchase price and the sale price of an assetHistory of tax rates on regular income and capital gains
18 The Most Important Federal Taxes (cont'd) The corporate income taxAccounts for 12% of federal tax revenue and 2% of all state and local taxes collectedCorporations are generally taxed on the difference between total revenues and expenses.
19 Table 6-2 Federal Corporate Income Tax Schedule
20 The Most Important Federal Taxes (cont'd) Double taxation (except Subchapter S)Corporation pays taxes on its profitsCorporation declares a dividend on after-tax profitsDividend income is taxedCost of limited liability
21 The Most Important Federal Taxes (cont'd) Retained EarningsEarnings that a corporation saves, or retains, for investment in other productive activitiesEarnings that are not distributed to stockholdersTax IncidenceThe distribution of tax burdens among various groups in society
22 The Most Important Federal Taxes (cont'd) Who really pays the corporate income tax?Tax incidence is distributed amongConsumersStockholdersEmployees
23 The Most Important Federal Taxes (cont'd) Social Security taxesSocial Security rates today are imposed on earnings up to roughly $98,000.Contributions are 6.2% for employers and 6.2% for employees.
24 The Most Important Federal Taxes (cont'd) Unemployment taxesPaid by employer0.8% of first $7,000 of wages for employees earning more than $1,500States may levy an additional tax up to 3% based on record of the employer
25 Tax Rates and Tax Revenues State and local governmentsTaxes imposed on goods and services yield more revenues than income taxesA fundamental issue is how to set tax rates to extract the largest possible payments
26 Tax Rates and Tax Revenues (cont'd) Sales TaxesTaxes assessed on the prices paid on a large set of goods and servicesAd Valorem TaxationAssessing taxes by charging a tax rate equal to a fraction of the market price of each unit purchased
27 Tax Rates and Tax Revenues (cont'd) Static Tax AnalysisBased on the assumption that changes in the tax rate leave the tax base unaffectedDynamic Tax AnalysisRecognizes that higher tax rates may shrink the tax base
28 Tax Rates and Tax Revenues (cont'd) If the disincentive effects of higher tax rates are small, static analysis may give a fairly accurate estimate of the change in tax revenues resulting from a tax rate change.As tax rates escalate, members of the public have a greater incentive to remove their activities from the tax base; a dynamic analysis would be necessary to determine the overall effect on government revenues.
30 E-Commerce Example: Even During a Revenue Boom, States Seek to Tax Internet Sales State governments seek to expand their sales tax bases by taxing items shipped from other states ordered online.State governments have been less than successful collecting, even though tax forms have a line item for such reporting.
31 Effect of Increasing Internet Sales on Tax Revenues
32 Tax Rates and Tax Revenues (cont'd) Maximizing tax revenuesDynamic tax analysis predicts ever-higher tax rates bring about declines in the tax base.At sufficiently high rates the government’s tax revenues begin to fall off .
34 Taxation from the Point of View of Producers and Consumers Excise TaxA tax levied on purchases of a particular good or serviceUnit TaxA constant tax assessed on each unit of a good that consumers purchase
35 Taxation from the Point of View of Producers and Consumers (cont'd) Excise taxes on gasoline become added costs of production.This shifts the supply curve up by the amount of the unit tax.Consequently, the equilibrium price of gasoline rises and the equilibrium quantity declines.
36 Figure 6-4 The Effects of Excise Taxes on the Market Supply and Equilibrium Price and Quantity of GasolineNote the effect of changing the slope of the demand curve.
37 Who Pays the Tax?In the previous example, consumers pay three- fourths of the excise tax and producers absorb the remainder.
38 Financing Social Security Today’s seniors are beneficiaries of rapidly increasing levels of federal spending.Probably half of all federal spending will go to the elderly by 2025.Medicare and Social Security
39 Financing Social Security Social Security was founded in 1935, as the United States was recovering from the Great Depression.A political attempt at social engineeringMeans of guaranteeing a minimum level of pension benefitsEarly recipients had high rates of return on their Social Security contributions
40 Financing Social Security (cont'd) Social Security ContributionsMandatory taxes paid out of workers’ wages and salariesRate of ReturnProportional annual benefit that results from making an investmentInflation-Adjusted ReturnMeasured in terms of real goods and services, after effects of inflation taken out
41 Financing Social Security (cont'd) Social Security facesSlow growth in membershipLess workers per retireeNegative rates of returnBenefits exceeding taxes
42 What Will it Take to Salvage Social Security? There are five options to considerRaise taxesReduce retirement benefit payoutsReduce disability paymentsReform immigration policiesFind a way to increase the rate of return
43 Figure 6-5 Private Rates of Return on Social Security Contributions, by Year of Retirement
44 What Will it Take to Salvage Social Security? (cont'd) Raise taxesEither increase the tax rate or expand the tax base
45 Example: Business Incorporation Could Dodge a Broadened Payroll Tax The Social Security payroll tax is currently applied only to the first $98,000 of income.What if this limit were removed?For example, someone making $1,000,000 would pay taxes on the entire amount.However, if they wanted to avoid a higher tax bill, they could form an “S corporation” and pay themselves less.
46 What Will it Take to Salvage Social Security? (cont'd) Reduce benefit payoutsIncrease the eligibility ageCut benefits to nonworking spousesIntroduce means testing
47 What Will it Take to Salvage Social Security? (cont'd) Reduce disability benefitsTighten requirements, or separate the disability benefit from the Social Security systemReform immigration policiesChanges in laws could offer hope of dealing with tax burdens and workforce shrinkage
48 What Will it Take to Salvage Social Security? (cont'd) Increase Social Security’s rate of returnInflation-adjusted return available on stocks 7–9% since the 1930sUncertainty of returnsPolitical pressure
49 Figure 6-6 Projected Social Security Rates of Return for Future Retirees
50 Funding the Public Sector ECON 151 – PRINCIPLES OF MACROECONOMICSChapter 6:Funding the Public SectorMaterials include content from Pearson Addison-Wesley which has been modified by the instructor and displayed with permission of the publisher. All rights reserved.