Govt. Taxation and Gov spending are the most direct way that the Gov influences the economy. We look at Gov spending and taxation in this chapter to get an idea about the size and characteristics of Government.
See page 111. Government spending over time. Growth has been in Fed spending.
Breakdown in Federal spending.
Transfer Payments 36% (SS, unemployment, AFDC, general assistance, etc.)
Housing subsidies, Food stamps and Medicaid/Medicare 17%
Less than 10% on education, ag programs, energy
Net interest - 15%
Total spending $1.5T
State and Local Spending - $1T, page 113.
Education, Public Welfare, and General Admin - 71%
Distinguish between spending on:
Four Measures of Size of Government (Federal, State and Local)
1. Government Purchase of Consumption and Investment Goods (19% of GDP)
2. Government Employment (17% of Labor Force)
3. Total Gov Exp, Including Transfer Pmts (32% of GDP)
4. Total Taxes and Other Revenues (31%) (Ignores deficit)
Defense spending and govt purchases has remained fairly constant as a % of GDP, see p. 116. Growth has been in Transfer Payments.
Tax Freedom Day - May 6
Tax Spending Day - May 16
COGD - July 3, 1997 (total federal, state and local govt spending, federal regulatory costs)
FINANCING GOVERNMENT SPENDING
Personal Income Taxes - Largest source of revenue at Fed level. Required a Constitutional Amendment. 16th amendment to the Constitution.
1. Progressive tax system - higher the income, the higher the
indexed for inflation. See page 119. See page 125 - Capital gains NOT
indexed for inflation.
2. Proportional tax (flat tax)
Average tax rate = tax liability/taxable income
Marginal tax rate - tax rate on the last dollar of income.
Payroll Taxes - social security, Medicare, unemployment. 37% of Fed revenue comes from Payroll. Look at your payroll check. Almost as much goes to SS as to Fed Taxes.
Payroll taxes are said to be regressive. For example, SS maxes out at $61,200. Employee pays 7.65% and Employer pays 7.65% for a total of 15.3%. At the max of $61.2k, the SS tax is $9363. $9363 is the max that can be paid in. A person making $200,000 and paying in the max of $9363 is only paying 4.6% of their income.
SS problems. p.610-611. 1950 - 16 workers/SS recipient, 1970 4 workers, 1993, there were 3 workers, in 2030 there will be two workers!!
Sales taxes and Excise taxes - Sales tax is general, Excise tax is specific - alcohol, cigarettes, gas. Important source of revenue for state governments.
Property taxes - largest source of revenue for local governments.
Corporate Income taxes - Considered unfair due to the double taxation of corporate income - taxed once at the corp level and once at the shareholder level. Example: $100 of corp inc. 50% tax at corp level. $50 to shareholders. 50% tax to shareholders - only $25 is left after taxes.
Example: $20 int expense, $20 Div expense. Int is tax deductible, reduces tax liability. Dividends have to get paid with after tax income. Bias toward corp debt. Favorable tax treatment for debt. Unfavorable tax treatment for equity.
Borrowing - Debt. Deficit spending.
Neutral tax - nondistortionary tax. Doesn't distort buying patterns, production methods, work habits, tax reporting, incentives, etc....
Head Tax - lump sum tax levied on everyone. The only nondistortionary tax, neutral tax.
Income taxes, sales taxes, excise taxes, capital gains taxes are distortionary, meaning that they cause people to change their behavior. Because most taxes are distortionary, they result in economic inefficiencies which we call either: 1) deadweight loss to society or 2) the excess burden of taxation. When taxes cause people to change behavior, there are mutually beneficial exchanges and transactions that will not take place, resulting in a burden or loss from the tax.
Examples: A punitive sales tax results in lost sales. Example, the luxury tax on expensive boats, cars, custom vans, airplanes, yachts, etc. The results were disastrous for the yachting industry. Reduction in trade resulted in losses to society, some of which we can measure and some which we can't measure exactly. Losses to the potential yacht buyers who didn't buy yachts, bought something else as second choice. Losses to the yacht dealer who lost sales. Lost sales resulted in massive layoffs in the yacht building industry.
Example: High marginal tax rates cause people to change behavior in several ways: 1) work less - cut hours, quit second job, turn down consulting work, speaking engagements, etc. 2) engage in tax avoidance - not report income, get paid in cash, barter, etc 3) make investments based on tax considerations, not economic considerations, etc.
We can measure and/or show graphically the effect of a DWL or DWC. Assume that cigarettes are $1. See page 124 for graph. A 50 cent tax goes into effect. Consumers absorb 25 cents and sellers absorb 25 cents. Price goes up to $1.25. Consumers are now paying 25 cents extra and sellers are receiving 25 cents less ($1.25-.50 = .75), and that 50 cents per pack goes to the Government, raising about $15B for the Government. (Note: if they had estimated the revenue on the ORIGINAL Qd, the est would be $17.5B) The $15B is just a transfer from tobacco consumers and producers to the Government, and there is not net loss. However there are now less cigarettes purchased, and consumers and producers are worse off by the area of the triangle. The DWL triangle measures the cost of the reduction in trade and exchange caused by the tax. It measures the value of the mutually beneficial trade that now does NOT take place....
Tax incidence - the burden of taxation. In this case, the burden was 50% on sellers and 50% on buyers. Might vary.
TAX RATES, TAX REVENUES and the LAFFER CURVE -
Gov raises tax rates on income or consumption or capital gains, etc. to raise tax revenues. However, taxes raise prices, make goods more expensive and people will avoid tax burden if they can by changing their behavior - buying less, finding substitutes. An increase in the tax rate, will lead to a shrinkage in the tax base - the quantity of what is being taxed.
Example: DC raised the tax on gas from 10 cents to 30 cents per gallon, a 30 percent increase. Tax revenues only increased by 12 percent, not 30%. Why? People found substitutes for gas in DC - gas in Maryland, VA.
Example: Luxury Tax.
Example: Laffer Curve graphically shows the relation between Tax Rates and Tax Revenue. Under a progressive tax system, the response to tax rate changes will vary across different income groups.
For people in the lower income groups, higher tax rates will increase tax revenues and vice-versa. For people in very high income tax brackets, say 75% marginal tax bracket, a reduction in tax rates would actually increase tax revenue by increasing the tax base. High income individuals would respond by increasing the tax base by 1) working harder/longer, less vacation 2) reporting more income, 3) engaging in less avoidance, 4) having spouse work, etc... Incentives would change and behavior would change.
1980s - In early 80s there were 14 different progressive tax rates ranging up to a top rate of 70 percent. By 1988 there were only three - 15, 28 and 33%. Personal exemptions and standard deductions were raised. Tax brackets were indexed to avoid bracket creep.
Example:0 - 10,000 Tax rate = 10% 10,000-20,000 Tax rate = 20%
You make $10,000 and pay $1000 in taxes.
The price level doubles, and your salary doubles. You now pay $3000 in taxes. Your taxes went up by 3x and your salary went up by 2x, so your tax liability increased.
Page 129 shows the effect of the Tax Changes.
For the top 1 percent, the tax revenue went up by 51% over a ten year period. And for the top 10 percent, tax revenue went up by 29%. This high income group was on the backward bending part of the Laffer curve. For the bottom 50%, the tax revenue decreased by 8.5%.
In addition, the increase in capital gains taxes, REDUCED tax revenues.....
WHO PAYS THE TAX BILL?
1. Middle and upper income pay most of the taxes.
Top 1% pays 29% of all taxes collected (taxable income>$195,000)
Top 5% pays 47% of all taxes collected (income>$90,000)
Top 10% pays 59% of all taxes (income>$68,000)
Top 25% pays 80% of all taxes ($42,000+)
Top 50% pays 95% of all taxes ($21,000+)
Bottom 50% pays 5% less than $21,000
2. PEOPLE pay all taxes. See cartoon page 131. Corporations don't pay taxes, individuals pay taxes. Corporations collect the taxes, but individuals PAY the tax - shareholders, customers, or employees. Corporation is a legal fiction - papers.
THE COST OF GOVERNMENT - Do taxes measure the cost of government? "Not entirely."
1.Opportunity cost. If the government uses resources to provide highways, health care, missiles, schools, etc. it has to bid these resources away from uses in the private sector. Government spending is an approximate value of the opportunity cost of government.
2. Costs of tax compliance. Not measured in taxes paid. Costs of tax compliance are the resources to prepare, monitor and enforce tax legislation. Compliance costs could be an additional 5-7% of the taxes paid. Record keeping, bookkeeping, filing tax returns, payroll expenses, red tape, IRS audits, etc. Wasted time, effort and money.
Advantage of Flat Tax - lower costs of tax compliance.
3.Excess burden of taxation. Additional cost of government, not calculated in taxes paid. Distortions and economic inefficiency resulting from taxes. Changes in behavior. Tax avoidance for example. Tax shelters, etc. Investment and spending going for tax-saving considerations more than economic reasons.
4.Cost of regulation. Hidden. Example: air bags adding to the cost of a car.
Size of Government in Other Countries - see page 133.
Problems 2-5, 7, 10-11