Chapter 24 Taxes and Spending Chapter 24 Norton Media Library Nariman Behravesh Edwin Mansfield

Government Spending as a Share of the Economy, 1930-2006 The following slide shows total government spending (federal, state, and local) as a share of the economy. Total government spending accounted for only 9.4% of GDP in 1930, and only one third of this spending was at the federal level. Government spending, particularly at the federal level, soared from 1930 to 1970. Total government spending rose from 9.4% of GDP in 1930 to 30.2% of GDP in 1970. Since 1970, government spending has been relatively constant at about one-third of the U.S. economy.

The Size of Government Government Expenditures as a Share (%) of GDP 3.0 6.5 9.4 1930 Federal 8.4 15.7 7.3 State & local 1940 21.1 14.7 6.3 1950 24.1 16.5 7.6 1960 30.2 19.4 10.9 1970 32.8 21.0 11.8 1980 34.2 21.6 12.6 1990 31.9 19.0 12.9 2000 33.8 20.3 13.5 2006

How the Federal Government Spends (2006) Defense 19.7% Social Security 20.7% Net Interest 8.5% Transportation 2.6% Income Security 13.3% Other 13.3% Medicare and health 21.9% Sources: Economic Report of the President, 2007, and Statistical Abstract of the United States, 2007. Back to slide 29

How State and Local Governments Spend Insurance trusts 8.9% Education 28.8% Public welfare & Health 19.5% Administration & other 21.9% Transportation 5.5% Police & Fire Protection 4.9% Utilities & liquor stores 6.9% Interest on debt 3.6% Sources: Economic Report of the President, 2007, and Statistical Abstract of the United States, 2007.

Financing the Public Sector: Taxation In order to make available public and correct inequity, government must free up resources from the production of private goods. Taxes shift resources from private to public use Taxing households and businesses reduces their incomes and spending, the private demand for products decreases, as does the private demand for resources. This is known as Deadweight Loss

THE U.S. TAX STRUCTURE Federal Government Personal Income Tax Collection of Taxes Federal Government Personal Income Tax Corporate Income Tax

(Social Security)

THE U.S. TAX STRUCTURE State Governments County and City Governments Collection of Taxes State Governments Personal Income Tax Sales Tax County and City Governments Property Taxes

TAXES Tax Incidence The Tax Incidence or Tax Burden is the determination of who actually pays the tax. Government must determine how to appropriate taxes from the citizens.

THE U.S. TAX STRUCTURE Personal Income Tax Corporate Income Tax INCIDENCE OF U.S. TAXES Personal Income Tax Individual Corporate Income Tax Stockholders – Consumers Sales Taxes Consumers Property Taxes Owner or Renter

TAXES Tax Incidence Benefits-Received Principle Ability-to-Pay Principle

Benefits Received versus Ability to Pay The benefits-received principle is the idea that people who receive the benefit from government-provided goods and services should pay the taxes required to finance them. The ability-to-pay principle is the idea that people who have greater income should pay a greater proportion of it as taxes than those who have less income.

THE TAX BURDEN Progressive Tax Regressive Tax Proportional Tax Flat Tax

Progressive, Proportional, and Regressive Taxes A progressive tax is one whose average tax rate increases as the taxpayer’s income increases. A regressive tax is a tax whose average tax rate decreases as the taxpayer’s income increases. A proportional tax is a tax whose average tax rate remains constant as the taxpayer’s income increases. A flat tax is a tax which takes the same monetary amount regardless of income.

Progressive, Proportional, and Regressive Taxes In general, progressive taxes fall relatively more heavily on high-income households while regressive taxes are those that fall relatively more heavily on the poor.

Progressive, Proportional, and Regressive Taxes Taxes are classified as progressive, proportional, or regressive, depending on the relationship between average tax rate (total tax paid as a percentage of income) and marginal tax rate (the rate paid on each additional dollar of income).

Top marginal tax rate (%) Tax year Top marginal tax rate (%) Taxable income over-- PRESIDENT GROWTH RATE 1913 7 500,000 WILSON 1918 77 1,000,000 1922 58 200,000 HARDING 1923 43 COOLIDGE 1925 25 100,000 1932 63 ROOSEVELT -1.3% 1936 79 5,000,000 1940 81 8.1% 1942 88 18.5% 1951 94 400,000 EISENHOWER 8.7% 1965 70 KENNEDY 1.7% 1981 38.5 215,400 REAGAN -0.2% 1986 28 29,750 4.3% 1993 39.6 89,150 CLINTON 4.0% 1994 250,000 2003 35 311,950 BUSH 3.9%

TAX APPLICATIONS: Identify whether progressive, regressive, or proportional Personal Income Tax Progressive Sales Tax Regressive Corporate Income Tax Proportional Payroll Taxes Property Taxes

Tax Progressivity in the U.S. The majority view of economists is as follows: The Federal tax system is progressive. The state and local tax structures are largely regressive. A general sales tax and property taxes are regressive with respect to income. The overall U.S. tax system is slightly progressive.

THE TAX ISSUE The Liberal Position

The Conservative Position THE TAX ISSUE The Conservative Position

End Chapter 24