Chapter 7-- The Government Sector

1. The Growing Economic Role of Government
1. In 1993 President Clinton was quoted as saying, "This is the end of the era of big government"
1. The intention was to streamline the federal government-- curb the waste, trim the fat.
2. In his last State Of The Union Address, the message seemed to be just the opposite-- expansion of government's role in healthcare and education, and a host of other projects requiring massive amounts of government spending.



2. Don't just blame Clinton, though. Since the beginning of WWII, the Federal Government has forced its way into every aspect of economic life.
1. The Great Depression, perhaps the story of 20^th century economics, eventually ended with the most massive government spending project ever-- World War II.



3. Four Basic Government Influences
1. Levy taxes-- almost $2.5 Trillion a year!
2. Spend a little more than $2.5 Trillion providing services and operating the government.
3. Redistributes Income-- plays "Robin Hood" with Social Security, Medicare, Welfare, grants to each state.
4. Regulates the economy-- ensures competition.



2. Government Spending
1. Federal Spending
1. Pie Chart on page 127
1. Where it comes from . . .
2. Where it goes . . .



2. FICA taxes make up 34% of the federal government's tax revenues.
1. Imagine what would happen if proponents of "investing your own Social Security contributions" had their way. That 34% that pays present day retirees would no longer be available.



3. A word about corporate taxes:
1. If you think about it, who really pays the 11% corporate taxes? Don't companies add taxes to the "cost of doing business" and simply just pass them on to consumers?



4. Half of what's taken in by the federal government, comes right back to her citizens-- whether they pay in or not. This is income redistribution. These payments (entitlements) are SS, Med, VA benefits, Welfare benefits.
1. These payments are often called "transfer payments," since they transfer wealth to those without the means to meet their needs.



5. Transfer payments have increased dramatically over the years. Why?
1. Some may say it reflects our "moral decay." Giving people who believe everyone owes them something "handouts"for doing absolutely nothing.



2. But, we do indeed have hungry people without means or ability to support themselves. And it is more moral to feed our hungry and care for our sick than to do otherwise.



3. We also have many more senior citizens than we used to have.
1. And, they receive checks with yearly cost-of-living-adjustments (COLAs).
2. Incidentally, more people believe that Elvis is alive than believe they'll ever get a Social Security check!



6. National Defense
1. It costs $1,000 per person each year to defend our country against attacks from God knows whom.
1. It used to be the "Evil Empire," the USSR.
2. Now we have to help protect them from themselves.



7. Interest on the National Debt
1. Who gets it? Holders of US Government debt securities-- treasury bonds, bills, and notes.
2. We must pay interest to those who lend the government money, and many of them are foreigners.
3. If there was no debt, presidents and congresses would have 14% more money to play with!



2. State and Local Government Spending
1. All 50 states combined spend only about half of what the federal government spends each year.



2. Most expenditures are for health, education, and welfare.
1. The states pay the tab for the public schools in America.



3. Spending for police protection has increased substantially.



4. Prisons are springing up all over the place in our region.



5. We spend a great deal on economic development programs.
1. With mixed results. It seems that whatever the government can do, private industry can do better in most cases.



6. In short, we are asking state and local governments to do more and more and of course, we are reluctant to let them raise our taxes to support these programs. In fact, we want to pay them less to do it all.
1. What the government gives it must first take away--Coleman (p.130)



3. Government Purchases vs. Transfer Payments
1. The mix is about 50-50. Half of all government revenues are paid out in transfer payments to Social Security, Medicare, Medicaid, Food Stamps, VA benefits.



2. The other half is government spending on public goods & services, and to keep the governments running.



3. In the chapters on consumption and investment we have repeatedly shown the formula for gross domestic product (GDP):
1. GDP = C+I+G+X



4. "G" in the formula is for government spending. Please note that we do not include transfer payments in GDP!
1. GDP is the total of final purchases by households, businesses, and governments in our economy.



2. Transfer payments by the government to individuals are not final expenditures since recipients ultimately spend all or most of them on goods and services. This final spending is counted in GDP.



3. To count transfer payments would be to double-count these monies in our calculation of GDP.



3. Taxes ( The Good Lord giveth, and Uncle Sam taketh away.)
1. Average Tax Rates (ATR)
1. How much of your taxable income is taxed?
1. Well, first what is taxable income?
2. Your author (Professor Slavin) chooses not to use the IRS definition of taxable income-- Gross Income - Exemptions - Standard (or Itemized) Deductions.
3. Instead, he chooses to discuss how much tax-- all tax-- we pay compared to our gross earnings.



2. Formula for ATR:
1. ATR = Taxes paid / Gross Earnings

1. If you paid $5,000 in taxes-- all taxes-- last year, and you earned $20,000 in gross earnings, your Average Tax Rate was 25%.



1. That seems simple enough, right? But, government bureaucrats (and economists) usually like to spice things up a bit, don't they! We all know that we don't all pay the same Average Tax Rates on our income.



2. In some ways, the rich have a lower ATR than the poor.
1. Sales and excise taxes take a smaller bite out of their total incomes.
2. Moreover, their SS payments stop once they've reached $72,600 (for 1999) in annual income.



3. But, flat taxes keep everyone's ATR the same.



4. And our progressive marginal tax rates with our federal income tax structure increase ATR for the rich.



1. The Marginal Tax Rate (MTR)
1. This is what most of us actually think about when we consider what the tax rate is.



2. You've heard the question, "What's your tax bracket?." That's the same as asking, "What's your marginal tax rate?."



3. The Marginal Tax Rate is the amount of tax levied on an additonal dollar of income.



4. Formula for MTR:
1. MTR = change in taxes paid / change in gross earnings.
2. If your overtime earnings of $2,000 caused you to pay an additional $800 in taxes, your marginal tax rate was $40%. For every additional dollar you earned, you paid 40 cents in taxes.



3. Building on the previous example where you paid $5,000 in taxes-- all taxes-- last year, and you earned $20,000 in gross earnings, your Average Tax Rate was 25%. Now add the overtime earnings and the additional taxes:



4. ATR = taxes paid / gross earnings; $5,800 / $22,000 = 26.4%
1. But remember, your Marginal Tax Rate went up to 40%.
2. In other words, your overtime basically forced you into a higher tax bracket.



2. Tax Brackets-- A Way to See Average and Marginal Rates in Action.
1. We'll now exclude all other taxes but the Federal Income Tax in our discussion, for now.



2. For the tax year 1999:

1. To see how marginal rates work, consider that your're single (yeah, baby, yeah!) and on December 15, 1999, your taxable income on your (YTD) earnings were $25,750. All along, you have been taxed at a 15% rate.



2. Guess what? The additional income you earn between December 15^th and 31^st is going to be taxed at what rate? Yeah, 28%. 28% is your new marginal rate.



3. So you will owe Uncle Sam 15% of $25,750 plus 28% of the additional earnings.



1. Types of Taxes
1. Direct Taxes
1. Taxes on peoples' incomes. Direct taxes are taxes that each of us are required to pay-- or else, the tax man cometh after us. Employers are required by law to let the IRS know that we are working for them.



2. Indirect Taxes
1. These are taxes on things. Examples include sales taxes and excise taxes-- taxes on things like tires, gasoline, movie tickets, cigarettes, and liquor.



3. Progressive Taxes
1. A progressive tax places the greatest burden on those who are most able to pay.



2. The best example of a progressive tax is our federal personal income tax.



3. With the federal income tax, people at the low end of the income spectrum pay up to 15%, while those at the high end pay up to 39.6%.
1. Prior to 1981, the federal income tax was even more progressive with the top rate at an astounding 70% of taxable income!



2. Since 1981 the top rate has moved down to 50%, then 28%, 31%, and 39.6%.



4. Proportional Taxes
1. These are the flat taxes that we've all heard about and experienced.



2. Our Pennsylvania state income tax is a proportional tax with a rate of 2.8% for individuals.



3. Proportional taxes place the same relative burden on all-- rich and poor.
1. For example, a 1% local income tax places a $10,000 a year burden on individuals earning $1 million in a given year, and a $100 burden on individuals earning only $10 thousand in a year.



4. Some argue that while the flat tax might sound fair, it is not. The argument: it is harder for a family earning only $10 thousand to come up with the $100 in local income tax, than it would be for those who earn $1 million to come up with the $10 thousand in taxes.



5. Regressive Taxes
1. These are taxes that place more burden on lower incomes than higher ones.



2. Yes, they do exist! Take Social Security, please. Workers pay 6.2% of their incomes up to a maximum of $72, 600 for 1999. Those people earning more than that pay no more SS tax. Therefore, the burden mainly falls on those who earn less.



3. It has been argued that the so-called sin taxes-- those on alcohol and tobacco are regressive supposing that the bulk of these "goods" are consumed by those with lower incomes.



4. In fact, our author (Professor Slavin) believes that all taxes are regressive, burdening the poor more than the rich! It may be popular to bash the rich, but personally, I believe that punishing the rich with high taxes ultimately punishes the poor as well. Why? Because the rich provide capital for business investment which builds and expands industries that employ people. Excessive taxation removes investment dollars, and that stifles economic growth. We have never ever been able to tax ourselves into prosperity! What do you think?



2. Sources of Federal Revenue
1. The Personal Income Tax
1. This is the largest of all sources of revenue for our federal government (46%).



2. Until WWII, the personal income tax was small. Congress said at the time that we needed an increase in the income tax to fund the war.
1. How long has it been since WWII ended? Let's see . . .1945 was 55 years ago. . .What? You mean they forgot to repeal the tax after the war?



2. The Payroll Tax
1. The payroll tax is FICA-- 7.65% from the employee, matched by the employer, which gives the federal government 15.3% of your earnings. Payroll taxes provide the federal government with about 34% of its tax revenues.



2. It is likely that the Social Security Trust Fund (better known as that big pot o'money that the politicians have raided for decades) may eventually run out of money (by the year 2013). Those of us who will consider retiring will put a drain on the system.
1. Retired baby boomers will outnumber working contributors at some time in the next 20 years.



3. In 1945 there were 42 workers for every beneficiary. Now there are only 3 workers paying in for every retiree collecting checks. By 2020, some guy working at Burger King will support the entire system. Ok, I made that up, but you get the picture.

1. The Corporate Income Tax
1. This is a tax on corporate profits with a present maximum rate of 35%. Corporate taxes comprise about 11% of federal tax revenues.



2. Excise Taxes
1. Sometimes called "use" taxes, excise taxes are really sales taxes with a different name. Whenever politicians want to raise taxes, they like to give the tax a different name so people won't suspect a tax increase. They speak of "revenue enhancement," or "contributions."



2. And as said before, sin taxes, which are another set of excise taxes are regressive, since the poor spend a greater portion of their incomes (even more than 100%!) on consumption than the rich who can afford to save 25% of their incomes.



1. Sources of State and Local Revenue
1. The Sales Tax
1. More than half of state revenues come from sales tax.
2. This tax is highly regressive-- the burden effectively falls on the poor more than the rich.
3. If you have lots of cash, you can often buy taxable items from merchants who will sell "under the table." Or, you can buy in a state which has no sales tax.



2. The Property Tax
1. More than 80% of all local tax revenues come from property taxes.
2. In many states property taxes go beyond real estate to include car registration as well.



3. The State and Local Fiscal Dilemma
1. Localities, and even states compete with one another when it comes to sales and property taxes. People often move out of or avoid living in areas with high sales and property taxes.



2. So while citizens expect more and more health, education, welfare, and police protection, they are unwilling to let state and local politicians raise sales and property taxes. This is the dilemma.



2. Taxes-- U.S. Compared With Other Countries
1. Despite what many Americans believe, we are not the most taxed nation on earth.



2. The bar graph on page 143 shows, in fact, that we are the least taxed of all the industrialized nations.
1. Wait a minute-- where's Fiji? Surely they are taxed less than us, aren't they? Well, if they're important enough to get a CNN camera crew at midnight of the new millennium, they're important enough to be shown on this bar graph!



3. And, keep in mind that half of the taxes paid come right back to our citizens in the form of transfer payments!



4. So, why do we complain so much about taxation?
1. Because many of us pay in, but don't apparently seem to get anything in return.



5. Take Denmark (please). Her citizens pay an amount equal to almost 60% of her GNP-- double what we pay! What do they get?
1. Plenty. Free medical for all, free college for all, and almost free day care services. Basically, they get cradle-to-grave security.
1. And one more very important thing: if you ever desire a sex change, Denmark is the place to go! They do more of them than anyone else (I think).



3. Taxation: Ability to Pay versus Benefits Received
1. Here's a tough question to ponder: Should what you pay in total taxes be based on your ability to pay, or on what benefits you receive?



2. It's not easy to answer (typical answer to any economics question!). Let's consider both choices.



3. If taxes would only be based on ability to pay, the rich would bear the heaviest burden.
1. They do, don't they?
2. Yes Virginia, they do suffer the highest tax burden, but only on the federal income tax. Remember, we said all taxes.
1. SS is regressive, and state & local taxes are usually proportionate.



4. Would you think it fair to be charged more sales tax on goods and services than someone behind you in line at a checkout counter simply because you have more money than they have? Of course not. That brings up the next basis for taxing citizens-- benefits received.



5. Gasoline prices have some built-in taxes. Supposedly, the tax revenues received by governments from the gas tax go to maintain roads. So the more you drive, the more you pay.



6. You are paying for the benefits you receive. What are the benefits? Better roads. You are using the roads and supposedly causing more wear-and-tear. Therefore, you, the heavy user, pay more.



7. Take police protection: most of us-- thank God-- don't seem to get any apparently tangible benefit from this. Police protection is probably best funded by taxes computed on an ability to pay basis.
1. That is, you pay according to your ability, and in return, get equal protection under the law.



2. A little bit of "Marx" there? Yes, the Communist Credo: "from each according to his ability, to each according to his need."



8. Imagine if after receiving police services you got a bill: Let's see now, one averted robbery-- that's $1,500, plus a surcharge for donuts . . . That would be an example of taxation by benefits received.



9. Basically, our system of taxes is based on a blend of both ability to pay and benefits received.



1. The Economic Role of Government
1. Provision of Public Goods and Services
1. If governments didn't provide national defense, police protection, public education, municipal transportation, water & sewer services, and a host of other public services, no one would!
1. Why? Because they would probably not be profitable. These "public goods" are given to citizens, for the most part, regardless of their ability to pay.



2. Redistribution of Income
1. As Robin Hood, the government "steals" from the rich and gives to the poor.
1. Or, might it be the other way around? I'll let you decide that one.



2. With all this complaining about welfare-- you know, taking money from the rich and middle class, and giving it to the poor-- don't forget that some big corporations also get a handout from the government!



3. "Corporate welfare" is what you might call the huge subsidies paid to farmers (most of them large corporate farms), tax breaks for rich oil companies, defense contractors, and payments or breaks given to a host of other "needy" recipients.



4. The effect of all this income churning is stability.



3. Stabilization
1. If we allowed the invisible hand to operated without restriction, we would have dramatic business cycles-- phases of super prosperity balance with phases of severe depression.



2. Government redistribution kind of "gives a push" to the economy at times, and also "puts on the brakes" when it's moving too fast. The desired effects are stable prices and low unemployment.



3. Also, just between us, don't you think we would live in an even more dangerous social environment if government didn't provide assistance?
1. There would be even be much, much more crime, violence, and poverty.



4. Economic Regulation
1. We have charged government with ensuring the following:
1. Competition among firms, environmental protection laws, child labor laws, the minimum wage, consumer protection laws, and a court system to settle disputes and punish offenders.



2. Some believe the government goes too far, restricting economic freedom.



3. The great Judge Oliver Wendell Holmes said: a man's freedom to swing his fist extends only as far as his neighbor's nose.
1. Not to be confused with Oliver Wendell Douglas who was a character on TV's Green Acres-- you remember, the show where this lawyer from Manhattan moves out to Hooterville and is surrounded by idiots for the rest of his life.



4. Yes, we must have considerable economic freedom. There is plenty of empirical evidence that suggests that.



5. But should firms be given the freedom to pollute or form huge monopolies?
6. As usual, when it comes to economic questions, there are no easy answers.