1. Chapter 16: Financing Government Section 1

2. Objectives
Explain how the Constitution gives Congress the power to tax and places limits on that power.
Identify the most significant federal taxes collected today.
Describe nontax sources of revenue.

3. Key Terms
fiscal policy: the methods used by the government to raise and spend money
progressive tax: a tax whose rate increases with one’s income
payroll tax: taxes withheld from employee paychecks
regressive tax: taxes levied at a fixed rate without regard to the taxpayer’s ability to pay them

4. Key Terms, cont.
excise tax: a tax on the manufacture, sale, or consumption of goods and services
estate tax: a tax on the assets of someone who dies
gift tax: a tax on gifts from one living person to another
customs duty: taxes on goods brought to the U.S. from abroad
interest: a charge for borrowed money, usually a percentage of the money borrowed

5. Introduction How is the Federal Government financed?
The Federal Government is financed largely by direct and indirect taxes.
The major taxes are the individual income tax, corporation income tax, payroll taxes, excise taxes, estate and gift taxes, and customs duties.
The government also raises a smaller amount of nontax revenue through interest, fees, and sales. 5

6. The Power to Tax
The first power granted to Congress by the Constitution is the power to tax.
Congress taxes to raise revenue to operate the federal government.
Congress also uses the taxation power to require or deny licenses for certain activities in order to serve the public interest.

7. The Power to Tax, cont.
Though taxes are used to fund the programs that the public expects, many complain about the burden placed on taxpayers.
How does this cartoon illustrate this view?
Political Cartoon Question Answer: The worker in the cartoon is faced with so many different government taxes that he not only receives no money, he owes the government more than he has earned.

8. Direct vs. Indirect Taxes
Checkpoint: How does a direct tax differ from an indirect tax?
A direct tax is levied upon a specific individual. Examples include taxes on personal property or income.
An indirect tax can be shifted to another person for payment. For example, a tax levied on a liquor producer is passed along to the consumers who buy the liquor in the form of higher prices.
Checkpoint Answer: Direct taxes are applied directly to and paid by specific individuals, while indirect taxes may be shifted to other people for payment. 8

9. Limitations on Taxation
Checkpoint: How does the Constitution limit the power to tax?
Congress can levy taxes only for public purposes.
Congress cannot tax U.S. exports.
Direct taxes on individuals must be distributed evenly among the States.
All indirect taxes must be set at the same rate in all parts of the country.
The federal government cannot tax the government functions of State or local governments, such as providing public education.
NOTE TO TEACHERS: The first four examples are the expressly stated limits on the federal power to tax. The last limitation is an IMPLIED limitation under the Constitution.
Checkpoint answer: Congress can tax only for public purposes, cannot tax exports, and must distribute direct taxes (except the individual income tax) evenly among the states, all indirect taxes must be set at the same rates in all parts of the country. 9

10. Limitations on Taxation, cont.
There are exceptions to these limitations:
The federal government can tax businesses operated by State and local governments if they are not considered to represent normal government functions.
The 16th Amendment, ratified in 1913, allows Congress to levy a direct individual income tax.
NOTE TO TEACHERS: A direct individual income tax would have to be levied so that each state would pay a portion of the tax equal to its percentage of the nation’s population, which is both unfair and impossible to enforce given the wide differences in personal wealth and population between states.

11. Income Tax
Income tax on individuals and corporations is the largest source of federal revenue.
Income taxes are progressive—higher earnings are taxed at a higher rate.
Insert the third column graphic showing differing tax rates from the Progressive Taxes feature on page 461 here in the right column, without the caption. Add Click to Enlarge feature.
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12. Individual Income Tax
Individual income tax is levied on each person’s earnings for the previous year, minus certain exemptions and deductions.
Tax returns for the previous year must be filed by April 15th. The IRS receives more than 120 million returns each year.

13. Individual Income Tax, cont.
Individual income taxes provide the bulk of federal revenue.
Most people have income taxes withheld from their paychecks. Others pay estimated taxes.

14. Corporation Income Tax
Each corporation must pay income tax.
There are many deductions allowed. For example, churches and nonprofit or charitable organizations pay no corporate income tax.

15. Payroll Taxes
The federal government collects payroll taxes to finance Social Security, Medicare, and the unemployment compensation program.
These are regressive taxes, paid at a fixed rate regardless of income.

16. Excise Taxes
Excise taxes are often figured into the retail price of goods and services.
Excise taxes on tobacco, alcohol, and gambling are called sin taxes, while those on luxury goods are called luxury taxes.

17. Gift and Estate Taxes
Gift taxes are levied on gifts from one person to another, while estate taxes are levied on the assets of someone who dies.
Most estates are not subject to the tax. Gifts up to $12,000 in one year are tax-free.

18. Customs Duties
Customs duties, also called tariffs or import duties, are charged on many goods imported into the United States.
They were once the main source of federal income, but are now minor.

19. Nontax Revenues
Checkpoint: What are three examples of federal nontax revenues?
The government receives interest on money borrowed from the Federal Reserve System and other loans.
The government also charges fees for issuing passports, copyrights, patents, and trademarks.
The sale or lease of public lands also generates government income.
NOTE TO TEACHERS: The US Mint earns a profit on the creation of coins, while the US Postal Service sells millions of dollars of mint-condition stamps to collectors each year.
Checkpoint Answer: The government receives interest on loans, charges fees for passports, copyrights, patents, and trademarks, and sells or leases public lands. 19

20. Review
Now that you have learned about how the Federal Government is financed, go back and answer the Chapter Essential Question.
How should the federal budget reflect Americans’ priorities?

21. Chapter 16: Financing Government Section 2

22. Objectives Describe federal borrowing.
Explain how the Federal Government’s actions can affect the economy.
Analyze the causes and effects of the public debt.

23. Key Terms
deficit: the shortfall created when income is lower than expenses
surplus: the excess created when income is higher than expenses
demand-side economics: the view that increased government spending will create higher employment, boost the economy, and raise tax revenues

24. Key Terms, cont.
supply-side economics: the view that lower taxes, not greater government spending, will boost the economy
public debt: the total amount of money owed by the federal government

25. Introduction
What effect does borrowing have on the federal budget and the nation’s economy?
Borrowing can be used to provide an economic stimulus for the nation and to pay off budget deficits in times of crisis or overspending.
However, such borrowing leads to future deficits and higher interest payments on the increasing public debt. 25

26. The Power to Borrow
The Constitution gives Congress the power to borrow money. For 150 years Congress used this power to:
Pay for crises such as wars
Pay for large-scale projects such as the construction of the Panama Canal
For most of the past 80 years, the government has borrowed money to pay for yearly budget deficits because it spends more than it raises from taxpayers.

27. Deficits and Surpluses
The government did not have a budget surplus from 1969 to 1998.
The government creates the budget based on estimates.
What factors mentioned on the chart likely affected the budget for that year?
Graph Question Answer: In 1951 the combination of a booming economy and the Korean War led to a slight surplus, in the 1980s, the arms race combined with lower taxes to produce large deficits, in 2000 a balanced budget, higher taxes, and lower military spending produced a surplus, and in 2008, the cost of Social Security and two wars combined with a failing economy to produce a large deficit.

28. The Depression
At the height of the Great Depression, one fourth of the nation’s labor force was unemployed and 18 million were dependent on public relief programs.
State governments, private charities, and banks were all overwhelmed.
The traditional approach was to keep government involvement in the economy limited and let the free market solve the problem.

29. Keynesian Economics
In contrast, President Roosevelt’s New Deal used the ideas of John Maynard Keynes to stimulate the economy.
Keynes said that government should spend heavily on public programs during times of high unemployment.

30. Supply-Side Economics
Under President Reagan, the theory of supply-side economics took hold.
This theory says that lowering taxes increases the supply of money in private hands and boosts the economy without higher government spending.
In 2008, supply-side supporter George W. Bush approved both an economic stimulus plan and a $700 billion bailout of home lending institutions, both Keynesian measures for dealing with a financial crisis.

31. Borrowing Money
Checkpoint: How does the federal government borrow money?
Congress must authorize all federal borrowing. The Treasury Department then borrows money by selling securities to investors.
Securities are notes in which the government promises to repay a certain sum, plus interest, on a certain date.
Short term securities are usually Treasury notes, also called T-bills.
Long term securities are typically government bonds.
Checkpoint Answer: Congress must authorize borrowing, which is done by the Treasury Department through selling securities such as treasury notes and bonds to investors . 31

32. Borrowing Money, cont.
Investors in U.S. securities include both American and foreign individuals, banks, investment companies, and other financial institutions.
To which group of investors does the government owe the most?
Graph Question Answer: According to the graph, the government owes the most to itself, followed by foreign investors.

33. The Public Debt
The U.S. government can borrow money while offering lower rates of interest than those charged to private investors.
This is because U.S. securities are seen as safe investments and their interest is not taxed.
Still, borrowing so much money has produced a huge public debt for the federal government.
This debt includes all the borrowed money not yet repaid plus the interest owed.

34. The Public Debt
The public debt has exploded over the past 30 years, passing $1 trillion for the first time in 1981.
About 1 in every 10 dollars spent by the U.S. government now goes to paying interest on the public debt.

35. The Public Debt, cont.
There is no constitutional limit on the public debt.
Congress has put limits on the debt but simply raised them when needed.
The amount of the debt is hard to imagine and will affect future generations of taxpayers.

36. Review
Now that you have learned about the effect borrowing has on the federal budget and the nation’s economy, go back and answer the Chapter Essential Question.
How should the federal budget reflect Americans’ priorities?

37. Chapter 16: Financing Government Section 3

38. Objectives Identify the key elements of federal spending.
Define controllable and uncontrollable spending.
Explain how the President and Congress work together to create the federal budget.

39. Key Terms
entitlement: benefits that must be paid under federal law to everyone who meets the eligibility requirements
controllable spending: items in the federal budget that the government can increase or decrease spending on each year

40. Key Terms, cont.
uncontrollable spending: budget expenses that are either fixed by federal law or are largely out of the government’s control from year to year
continuing resolution: emergency legislation passed by Congress to fund federal agencies whose budget appropriations have not been approved by the required deadline

41. Introduction How is federal spending determined?
The various federal agencies submit budget proposals to the Office of the President, which reviews and alters them before presenting a complete budget to Congress.
Congress makes further adjustments to the budget until appropriations bills are approved and sent to the President to be vetoed or signed into law. 41

42. Spending Priorities
The federal government spends over $700 billion a year on entitlement programs.
These are benefits that must be paid under federal law to people who meet eligibility requirements.
Social Security, Medicare, Medicaid, and food stamps are major examples.

43. Spending Priorities, cont.
The Department of Defense spent more than $636 billion on national defense in 2010.
This figure does not include all defense-related federal expenditures.
Treasury Department payments on the public debt are now the fourth-largest category of federal spending.
Chart question answer: Expenditures on Health and Human Services and Social Security have grown dramatically as a percentage of total federal expenditures, as have interest payments on the public debt. The Other category has shrunk significantly.

44. Controllable Spending
Congress and the President can decide how much to spend on many specific items in the federal budget.
Such controllable spending includes national parks, highway projects, military equipment, educational aid, and civil service pay.
This spending is also called discretionary spending.

45. Uncontrollable Spending
Many public programs have uncontrollable spending limits that neither Congress nor the President can change.
This includes the interest due on the vast federal debt.
Most entitlements—Social Security benefits, food stamps, and so on—are also largely uncontrollable. Congress can only redefine the eligibility standards or reduce the amount of benefits.
Nearly 80% of all federal spending now falls into the uncontrollable category.

46. Overview of the Federal Budget
Checkpoint: How is the budget both a financial and political statement?
Financially, the budget is a detailed estimate of federal income and expenditures for the upcoming year.
Politically, the budget is also a declaration of the President’s public policy plans, some of which will be accepted, altered, or rejected by Congress over a period of several months.
Checkpoint Answer: Financially, the budget is a lengthy, detailed estimate of federal income and expenses for the coming fiscal year. Politically, it represents the President’s proposed public policies as accepted, modified, or rejected by Congress, and so is a source of political guidance and a topic of serious political debate. 46

47. The President
At least eighteen months before a fiscal year, each federal agency prepares detailed estimates of its spending needs for that year.
These plans are submitted to the President’s Office of Management and Budget (OMB).
The OMB reviews and adjusts these budget proposals.
The President then sends the final budget request to Congress on the first Monday in February.

48. Congress
The House and Senate Budget Committees study the budget proposal with the help of the Congressional Budget Office (CBO).
The CBO is Congress’s independent version of the OMB.
The Budget Committees each submit a Budget Resolution that is debated and voted on in each house.
The two Budget Resolutions are merged into one version that Congress votes on by May 15th.

49. Congress, cont.
The House and Senate Appropriations Committees use the income and spending guidelines in the Budget Resolution to help them decide how to divide money among federal agencies.
Each Appropriations Committee creates 13 spending bills in each house of Congress, which are then resolved in 13 separate spending bills for federal agencies.
Congress votes on the final version of each spending bill.

50. Congress, cont.
Appropriations subcommittees hold many public hearings to examine agency requests and take testimony from lobbyists and others about specific spending plans.
Why do you think these hearings are open to the public?
Question Answer: Student answers will vary, but they should note that Congress is interested in gauging the opinion of private citizens and industries about the spending plans for the coming year, as federal spending will affect public policies that in turn affect these citizens and industries.
NOTE TO TEACHERS: In above image, singer and songwriter John Legend testifies before a House Appropriations hearing on funding for the arts.

51. Approving the Budget
The total cost of all appropriations bills cannot be greater than the maximum limit set by the Budget Committees.
Each appropriations bill approved by Congress goes to the President to be vetoed or signed into law.
If, as often happens, an appropriations bill is not approved by October 1, Congress must pass a continuing resolution to fund any affected agencies to ensure their continued operation.

52. Review
Now that you have learned about how federal spending is determined, go back and answer the Chapter Essential Question.
How should the federal budget reflect Americans’ priorities?

53. Chapter 16: Financing Government Section 4

54. Objectives
Describe the overall goals of the Federal Government’s actions in the economy.
Explain the features and purposes of fiscal policy.
Explain the features and purposes of monetary policy.

55. Key Terms
gross domestic product: the total value of all goods and services produced in a country each year
inflation: a general increase in prices throughout the economy
deflation: a general decrease in prices throughout the economy
recession: an absence of GDP growth and a shrinking economy
fiscal policy: the government’s powers to tax and spend to influence the economy

56. Key Terms, cont.
monetary policy: the government’s power to influence the economy by regulating the money supply and the availability of credit
open market operations: the process of buying or selling government securities from the nation’s banks
reserve requirement: the amount of money that the Federal Reserve Board says banks must keep on reserve
discount rate: the rate of interest a bank must pay when it borrows money from a Federal Reserve bank

57. Introduction
How does the Federal Government achieve its economic goals?
The Federal Government tries to maintain a healthy, growing economy through a combination of fiscal policies.
These involve taxation, government spending and monetary policies based on controlling the money supply and the availability of credit. 57

58. Overall Economic Goals
The federal government seeks to achieve full employment, price stability, and economic growth.
Full employment means that everyone able and willing to work can find a job.
Price stability means that overall prices for goods and service do not rise too high (inflation) or fall too low (deflation).
Economic growth means that the gross domestic product (GDP) steadily increases, avoiding recession.

59. Overall Economic Goals, cont.
Checkpoint: How can inflation and deflation affect the economy?
High inflation means that dollars buy less than they previously did, which robs people of purchasing power.
Deflation hurts the economy by making it harder to borrow money and lowering the money earned by farmers and other producers, who receive less for their goods.
Checkpoint Answer: Inflation lowers purchasing power, hurting consumers. Deflation lowers earning power, hurting producers, as well as making it harder to borrow money. 59

60. Fiscal Policy
Fiscal policy is the government’s attempt to influence the economy through taxation and spending.
In general, higher government spending increases economy activity, while less spending dampens activity.
Tax increases tend to slow economic growth, while tax cuts boost growth.
For many years, federal fiscal policy was limited. Very little of GDP came from federal spending. Today, federal spending accounts for about 20% of GDP.

61. Fiscal Policy, cont.
During economic downturns, policy makers usually increase federal spending, cut taxes, or both in hopes of expanding the economy.
In theory, tax increases or cuts in federal spending can slow inflation.
NOTE TO TEACHERS: The above image shows President George W. Bush signing the 2008 Economic Stimulus Act.

62. Monetary Policy
Monetary policy involves increasing or decreasing the money supply and easing or tightening the availability of credit.
The goal is to boost or slow down the economy as needed.
The seven-member Federal Reserve Board, or Fed, carries out U.S. monetary policy. Members are appointed to 14-year terms.
The Fed also helps stabilize the banking system by providing emergency funding.

63. Monetary Policy, cont.
Under the guidance of current Chairman Ben Bernanke, the Fed has three major tools for altering the money supply:
Open market operations
Reserve requirements
The discount rate
NOTE TO TEACHERS: The above image shows Federal Reserve Chairman Ben Bernake. 63

64. Open Market Operations
The Federal Reserve carries out open market operations by buying or selling government securities to and from banks.
Buying government securities gives banks more money to loan to individuals and businesses. This can boost business activity.
Selling government bonds to banks removes money from circulation, leaving banks with less money to loan or invest. This slows business activity.

65. Reserve Requirements
The reserve requirement is the amount of money that the Federal Reserve requires banks to keep in their vaults or on deposit with one of the 12 Federal Reserve Banks.
Money kept in reserve cannot be loaned or spent—it is out of circulation.
Increasing the reserve requirement lowers the amount of money in circulation, while decreasing the reserve requirement does the opposite.

66. The Discount Rate
The discount rate is the interest paid by banks borrowing from the Federal Reserve.
Raising the discount rate slows borrowing, which reduces the flow of money. Lowering it does the opposite.
How does this cartoon show the complexity of monetary policy?
Political Cartoon Question Answer: The cartoon implies that trying to find the proper balance between economic growth and interest rates is very difficult, because lowering one tends to raise the other.

67. Review
Now that you have learned about how the Federal Government achieves its economic goals, go back and answer the Chapter Essential Question.
How should the federal budget reflect Americans’ priorities?