Chapter 7 - The government sector. This chapter include objectives: Government spending, the graphing of the C + I + G line, types of taxes, the average and marginal tax rates, sources of government revenue, principles of taxation, the economic role of government.
Chapter 7 The Government Sector Copyright 2002 by The McGrawHill Companies, Inc. All rights reserved 71 Chapter Objectives • • • • • • • Government spending The graphing of the C + I + G line Types of taxes The average and marginal tax rates Sources of government revenue Principles of taxation The economic role of government Copyright 2002 by The McGrawHill Companies, Inc. All rights reserved 72 Introduction: The Growing Economic Role of Government • Most of the growth over the past seven decades was due to the Depression and World War II • Since 1945 the roles of government at the federal, state, and local levels have expanded – The seeds of that expansion were sown during the Roosevelt administration • The government exerts four basic influences – – – – It spends more than $2.5 trillion It levies almost that amount in taxes It redistributes hundreds of billions of dollars It regulates our economy Copyright 2002 by The McGrawHill Companies, Inc. All rights reserved 73 Where it comes from Corporate Income Taxes 10% Social Insurance Receipts 34% Other 4% Excise Taxes 4% Individual Income Taxes 48% Where it goes National Defense 16% Federal tax revenue: $2,019 billion Non-Defense Discretionary 19% Other Means-Tested Entitlements 6% Other Mandatory 6% Medicaid 7% Copyright 2002 by The McGrawHill Companies, Inc. All rights reserved Net Interest 11% Social Security 23% Medicare 12% Federal spending: $1,835 billion 74 2002 Proposed Spending by Category Budget of the United States Government , Fiscal Year 1999 International Affairs $21 B (1%) National Defense $301 B (16%) Medicare and Medicaid $342 B (19%) All Other Mandatory $232 B (13%) Domestic Discretionary $309 B (17%) Social Security $422 B (23%) Net Interest $208 B (11%) Copyright 2002 by The McGrawHill Companies, Inc. All rights reserved 75 State and Local Government Spending • Main expenditures – Education – Health – Welfare • Spending is a little more than half the level of federal spending • Police protection and prisons are now straining state and local budgets Copyright 2002 by The McGrawHill Companies, Inc. All rights reserved 76 Government Purchases versus Transfer Payments • The government spends $2.7 trillion a year – GDP = C + I + G + Xn – Approximately half is “transfer payments” • The largest transfer payment is social security • These payments end up in the “C” part GDP – Approximately half is “government purchases” • The largest government purchase is defense • These end up in the “G” part of GDP Copyright 2002 by The McGrawHill Companies, Inc. All rights reserved 77 Federal and State and Local Purchases Relative to GDP, 19602000 25 Total Government Purchases Total government purchases have been declining since the late 1960s and now constitute 16 percent of GDP 20 15 State and Local Purchases 10 Federal Purchases 1960 1965 1970 1975 1980 1985 1990 1995 Year Copyright 2002 by The McGrawHill Companies, Inc. All rights reserved 78 Federal and State and Local Transfer Payments as a Percentage of GDP, 19602000 Federal transfer payments have risen sharply since the mid1960s, while state and local transfer payments have also grown substantially since the early 1970s 16 14 Total Government Transfer payments State and Local Transfer Payments 12 10 Total government transfer payments have risen from just 6 percent of GDP in 1960 to more than 15 percent today Federal Transfer Payments 1960 1965 1970 1975 1980 1985 1990 1995 Year Copyright 2002 by The McGrawHill Companies, Inc. All rights reserved 79 Graphing the C + I + G + Xn Line To keep the graph as simple as possible, we are assuming the government spends a constant amount of money regardless of the level of disposable income 3,000 C+I+G C+I 2,000 C 1,000 45û 1,000 2,000 Disposable income ($) Copyright 2002 by The McGrawHill Companies, Inc. All rights reserved 3,000 710 The State and Local Fiscal Dilemma (Continued) • During the 1960s and 1970s the federal government helped states with increasing grantsinaid and general revenue sharing • The Reagan administration not only stemmed this increase, but strongly reversed it Copyright 2002 by The McGrawHill Companies, Inc. All rights reserved 745 The State and Local Fiscal Dilemma (Continued) • Neighboring states and local governments are in direct competition with one another for tax dollars – If one government’s tax rates rise too far above the levels of its neighbors, it citizens will vote with their feet • The 1998 Internet Tax Freedom Act declared a threeyear moratorium for online sales Copyright 2002 by The McGrawHill Companies, Inc. All rights reserved 746 Government Tax Rates as a Percentage of GDP, 1929 and 2000 35 Total: 30.6% 30 Tax Rates are almost three times as high as they were in 1929 State and local 25 20 15 Total: 11% 10 State and local Federal Federal 1929 Copyright 2002 by The McGrawHill Companies, Inc. All rights reserved 2000 747 Tax Receipts as a Percentage of GDP in the United States and Selected Western European Countries, 1999 60 50 40 30 20 10 *Please note: These are 1999 figures By 2000, U.S tax receipts were just 30.6 percent of GDP, and, assuming a major tax cut in 2001 they may soon fall below 30 percent of GDP Copyright 2002 by The McGrawHill Companies, Inc. All rights reserved 748 Two Principles of Taxation: I • Ability to pay principle – Ability to pay • Rich people would pay a much higher proportion of their incomes than the middle class • Middle class would pay a higher proportion of their incomes than the poor – Is this fair? • Possibly, but only if you are solely concerned with people’s incomes • It also depends on how you define the rich and middle class Copyright 2002 by The McGrawHill Companies, Inc. All rights reserved 749 Two Principles of Taxation: II • Benefits received principle – Some people receive more benefits than others – Applying the benefits received principle strictly could end up with absurd results – We are not always clear about the value of any benefits received Copyright 2002 by The McGrawHill Companies, Inc. All rights reserved 750 Two Principles of Taxation (Continued) • An example of the ability to pay principle is the federal personal income tax • An example of the benefits received principle is the federal and state tax on gasoline, which is geared to the number of miles driven • A tax based on both principles cannot be devised because they appear to be mutually exclusive – Therefore, some taxes are based on the ability to pay principle while others are based on the benefits received principle 751 Copyright 2002 by The McGrawHill Companies, Inc. All rights reserved The Economic Role of Government • Provision of Public Goods and Services • Redistribution of Income • Stabilization • Economic Regulation Copyright 2002 by The McGrawHill Companies, Inc. All rights reserved 752 Provision of Public Goods and Services • Some examples – – – – – – – Defense of the country Maintenance of internal order Provision of a nationwide highway network Provision of a money supply Provision of public education Running the criminal justice system Environmental protection Copyright 2002 by The McGrawHill Companies, Inc. All rights reserved 753 Redistribution of Income • The government redistributes hundreds of billions of dollars every year – Social security redistributes money from those currently working to those who have retired – Welfare for the poor • Examples are food stamps, Medicaid, disability payments and unemployment benefits – Welfare for the rich • Examples are subsidies to corporate farmers and tax breaks for defense contractors, oil companies, and other large corporations Copyright 2002 by The McGrawHill Companies, Inc. All rights reserved 754 Stabilization • Two basic goals of economic stabilization by the federal government – Stable prices with little or no inflation – Low unemployment • An economic rate of growth high enough to keep the unemployment rate to a minimum Copyright 2002 by The McGrawHill Companies, Inc. All rights reserved 755 Economic Regulation • The government provides the economic rules of the game – This must be done within the social and political context in which the economy operates • The government must allow individuals and business firms to operate with the maximum degree of freedom • There is little agreement as to how far economic freedom may be extended without interfering with society as a whole or the economic rights of specific individuals or business firms Copyright 2002 by The McGrawHill Companies, Inc. All rights reserved 756 Adam Smith’s Dos and Don’ts • Do – Protect society from the violence and invasion of other countries – Establish an exact administration of justice – Erect and maintain certain public works and institutions where private enterprise could not profit from doing so • Don’t – Do anything else Copyright 2002 by The McGrawHill Companies, Inc. All rights reserved 757 Conclusion • Until the 1930s, the federal government more or less followed the role prescribed by Adam Smith • The government’s economic role has expanded tremendously these last seven decades • It will continue to grow in the coming years Copyright 2002 by The McGrawHill Companies, Inc. All rights reserved 758 Big government, like rock ‘n’ roll, is here to stay Copyright 2002 by The McGrawHill Companies, Inc. All rights reserved 759 ... 2002 by The McGrawHill Companies, Inc. All rights reserved 7? ?33 Federal Personal Income Tax:The Top Marginal Tax Rate, 19542001 90 91% 80 70 % 70 60 50% 50 39.6% 40 31% 28% 30 20 10 1954 1960 1 970 1980 *During World War II... Purchases 10 Federal Purchases 1960 1965 1 970 1 975 1980 1985 1990 1995 Year Copyright 2002 by The McGrawHill Companies, Inc. All rights reserved 7? ?8 Federal and State and Local Transfer ... more than 15 percent today Federal Transfer Payments 1960 1965 1 970 1 975 1980 1985 1990 1995 Year Copyright 2002 by The McGrawHill Companies, Inc. All rights reserved 7? ?9 Graphing the C + I + G + Xn Line To keep the graph as