Chapter 14: Taxes and Government Spending

Section 1

Chapter 14: Taxes and Chapter 14: Taxes and Government Spending Government Spending

Section 1Section 1

ObjectivesObjectives

1. Identify the sources of the government’s authority to tax.

2. Describe types of tax bases and tax structures.

3. List the characteristics of a good tax.4. Identify who bears the burden of a tax.

Key TermsKey Terms

• tax: a required payment to a local, state, or national government

• revenue: the income received by a government from taxes and other nontax sources

• progressive tax: a tax for which the percentage of income paid in taxes increases as income increases

• proportional tax: a tax for which the percentage of income paid in taxes remains the same at all income levels

• regressive tax: a tax for which the percentage of income paid in taxes decreases as income increases

Key Terms, cont.Key Terms, cont.

• tax base: the income, property, good, or service that is subject to a tax

• individual income tax: a tax based on a person’s earnings

• corporate income tax: a tax based on a company’s profits

• property tax: a tax based on real estate and other property

• sales tax: a tax based on goods or services that are sold

• incidence of tax: the final burden of a tax

IntroductionIntroduction

• What are the features of a tax system?– Fairness– Simplicity– Efficiency– Certainty– Balance between tax revenue and tax rates

Government’s Authority to TaxGovernment’s Authority to Tax

• We authorize the federal government, through the Constitution and our elected representatives in Congress, to raise money in the form of taxes.– Taxation is the primary way that the

government collects money. Taxes give the government the money it needs to operate.

– The first power granted to Congress is the power to tax, which is the basis of all federal laws.

Limits on the GovernmentLimits on the Government

• There are also limits on the government’s power to tax.– The purpose of a tax must be “for the

common defense and general welfare.” A tax cannot bring in money that goes to individual interests.

– Federal taxes must be the same in every state.

– The government cannot tax exports, only imports.

Progressive TaxesProgressive Taxes

• Economists describe taxes based on their structure and according to the tax base.

• A progressive tax is a tax for which the percentage of income paid in taxes increases as income increases.

Other TaxesOther Taxes

• A proportional tax is a tax for which the percentage of income paid in taxes remains the same at all income levels.

• A regressive tax is a tax for which the percentage of income paid in taxes decreases as income increases.– A sales tax is regressive because higher

income households spend a lower proportion of their incomes on taxable goods and services.

Tax BasesTax Bases

• Different taxes have different tax bases.– The individuals income tax is based on a

person’s earnings.– The corporate income tax is based on a

company’s profits.– The property tax is based on real estate and

other property.– The sales tax is based on goods and services

that are sold.

Elasticities of Demand and Tax Effects Elasticities of Demand and Tax Effects

• Taxes affect more than just the people who pay them. • Producers often pass on a portion of tax to consumers.

– Generally, the more inelastic the demand, the more easily the seller can shift the tax to consumers.

Characteristics of a Good TaxCharacteristics of a Good Tax

– Simplicity—tax law should be easy to understand

– Efficiency—the tax should be able to be collected without spending too much time or money

– Certainty—it should be clear when the tax is due, how much is due, and how to pay the tax

– Equity—the tax system should ensure that no one bears too much or too little of the tax

Determining FairnessDetermining Fairness

• Economists have proposed two different ideas about how to measure the fairness of a tax.– The benefits-received

principle holds that a person should pay taxes based on the level of benefits he or she expects to receive from the government.

– The gasoline tax is an example of the benefits-received principle.

Determining Fairness, cont.Determining Fairness, cont.

• The ability-to-pay principle holds that people should pay taxes according to their ability to pay.

• Good taxes generate enough, but not too much, revenue. Citizens needs are met, but not to such an extensive degree that the tax discourages production.

Chapter 14: Taxes and Government Spending

Section 2

Chapter 14: Taxes and Chapter 14: Taxes and Government Spending Government Spending

Section 2Section 2

ObjectivesObjectives

1. Describe the process of paying individual income taxes.

2. Identify the basic characteristics of corporate income taxes.

3. Explain the purpose of Social Security, Medicare, and unemployment taxes.

4. Identify other types of taxes.

Key TermsKey Terms

• withholding: taking tax payments out of an employee’s pay before he or she receives it

• tax return: a form used to file income taxes• taxable income: the earnings on which tax must

be paid; total income minus exemptions and deductions

• personal exemption: a set amount that taxpayers may subtract from their gross income for themselves, their spouse, and any dependents

• tax deduction: a variable amount that taxpayers may subtract from their gross income

Key Terms, cont.Key Terms, cont.

• tax credit: a variable amount that taxpayers may subtract from the total amount of their income tax

• estate tax: a tax on the total value of the money and property of a person who has died

• gift tax: a tax on the money or property that one living person gives to another

• tariff: a tax on imported goods• tax incentive: the use of taxation to discourage

or encourage certain types of behavior

Individual Income TaxesIndividual Income Taxes

• The government’s main source of revenue comes from the federal tax on individuals’ taxable income.

“Pay-As-You-Earn” Taxation“Pay-As-You-Earn” Taxation

• The amount of federal income tax a person owes is determined on an annual basis.– To lessen the burden that one large yearly tax

would place on an individual and to make it possible for the government to meet its regular expenses, federal income tax is collected in a “pay-as-you-earn” system.

• This means that individuals usually pay most of their income tax throughout the year as they earn income.

Tax BracketsTax Brackets

• The federal income tax is a progressive tax, which rises with the amount of taxable income.

• Your range of income puts you in a specific tax bracket.

Withholdings and Tax ReturnsWithholdings and Tax Returns

• Employers help collect taxes by withholding money from your paycheck based on an estimate of how much you will owe in federal income tax for that year.

• After the calendar year ends, employers give their employees a report of how much income tax has already been paid. – Employees then fill out a tax return to send to

the federal government.

Tax Returns, cont.Tax Returns, cont.

• On your tax return, you figure out how much of your income is taxable.– Taxable income is a

person’s total income minus exemptions and deductions.

• Tax returns are due to the Internal Revenue Service by April 15.

Corporate Income TaxesCorporate Income Taxes

• Like individual income taxes, corporate income taxes are progressive.

• Determining corporate income taxes can be more difficult than determining an individual’s because businesses can take many deductions.– Companies often deduct the cost of

employee’s health insurance as well as many other costs of doing business.

Social Security and MedicareSocial Security and Medicare

• Employees also withhold money to help fund Social Security, Medicare, and unemployment insurance under the Federal Insurance Coalition Act (FICA).– Most of the FICA taxes you pay go to Social

Security benefits for retired people, surviving members of wage earners, and disabled people.

– The Medicare tax helps pay for health insurance for people over 65.

UnemploymentUnemployment

• The unemployment tax pays for “unemployment compensation” that people can receive when they are laid off.

Other Types of TaxesOther Types of Taxes

• Excise taxes—a general revenue tax on the sale or manufacture of a good or service such as gasoline, cigarettes, and other items

• Estate taxes—a tax on the total value of the money and property of a person who has died– As of 2008, if the total value of an estate is $2

million or less, there is no federal estate tax.

Other Types of Taxes, cont.Other Types of Taxes, cont.

• Gift taxes—a tax on the money or property that one living person gives to another– The goal of the gift tax is to stop people from

avoiding the estate tax by giving away property before they died.

• Import taxes—Tariffs, or import taxes, are taxes placed on imported goods.

Taxes That Affect BehaviorTaxes That Affect Behavior

• The government sometimes uses taxes to encourage good behavior, which is known as a tax incentive.– Tax credits are often

used as an incentive.– For example, people

who use solar power receive an income tax credit.

Chapter 14: Taxes and Government Spending

Section 3

Chapter 14: Taxes and Chapter 14: Taxes and Government Spending Government Spending

Section 3Section 3

Key TermsKey Terms

• mandatory spending: spending that Congress is required by existing law to do

• discretionary spending: spending about which Congress is free to make choices

• entitlement: social welfare program that people are “entitled to” benefit from if they meet certain eligibility requirements

IntroductionIntroduction

• How does the federal government spend its income?– Federal spending is divided up into mandatory

and discretionary spending.• Mandatory spending pays for Social Security,

Medicare, Medicaid, and other entitlements.• Discretionary spending pays for everything else,

including defense, education, law enforcement, environmental cleanup, and disaster aid.

Federal SpendingFederal Spending

• There are two types of government spending.

– Mandatory spending is money that Congress is required by existing law to spend on certain programs or to use for interest payments on the national debt.

– Discretionary spending is spending about which lawmakers are free to make choices.

Federal Spending, cont.Federal Spending, cont.

• The federal government spends the funds it collects from taxes and other other sources on a variety of programs.

Entitlement ProgramsEntitlement Programs

• Most of the mandatory spending items are for entitlement programs, which fund social welfare programs.

• The federal government guarantees assistance for all people who quality for such programs.

• Entitlements are a largely unchanging part of government spending.– Congress can only change the eligibility requirements

or reduce benefits if there is a change in the law.

Social SecuritySocial Security

• Social Security is a huge portion of federal spending.– About 50 million Americans receive monthly benefits from

the Social Security Administration.• The future of Social

Security is uncertain. – As the millions of baby

boomers—people born after World War II—start to retire, the ratio of existing workers, who pay for Social Security, to retirees will fall.

Medicare and MedicaidMedicare and Medicaid

• About 42 million people receive Medicare benefits.– It pays for hospital care and for the costs of physicians and

medical services.– Medicare costs have been

rising as a result of expensive technology and people living longer. It faces the same problem as Social Security.

• Medicaid benefits help low-income families pay for their medical expenses– The federal government

shares the cost of Medicaid with state governments.

Other Mandatory ProgramsOther Mandatory Programs

• Other means-tested entitlements benefit people and families whose incomes fall below a certain level. These entitlements include:– Food stamps and child nutrition programs– Retirement benefits and insurance for federal workers– Veterans’ pensions– Unemployment insurance

• In recent years, there has been a debate over governmentally funded universal healthcare.

Discretionary SpendingDiscretionary Spending

– Defense spending accounts for about half of the government’s discretionary spending.

– The Department of Defense uses this money to pay salaries of enlisted men and women as well as its civilian employees.

– This money also buys weapons, missiles, ships, tanks, airplanes, and equipment.

Discretionary Spending, cont.Discretionary Spending, cont.

• The remaining discretionary funds go to pay for the following:– Education and training– Scientific research– Student loans– Law enforcement– Environmental cleanup– Disaster relief

Federal AidFederal Aid

• Federal taxes are sometimes used to help state and local governments.– State and federal governments share the cost of Medicaid,

unemployment insurance, education, lower-income housing, highway construction, and dozens of other programs.

– States also rely on federal aid for disaster relief.

Chapter 14: Taxes and Government Spending

Section 4

Chapter 14: Taxes and Government Spending

Section 4

Key TermsKey Terms

• budget: an estimate of future revenue and expenses

• operating budget: a budget for day-to-day spending needs

• capital budget: a budget for spending on major investments

• balanced budget: a budget in which revenue and spending are equal

Key Terms, cont.Key Terms, cont.

• tax exempt: not subject to taxes• real property: land and any permanent

structures on the land to which a person has legal title

• personal property: movable possessions or assets

• tax assessor: an official who determines the value of property

State BudgetsState Budgets

• Governments plan their spending by creating a budget.

• The federal government has one budget while state governments have two budgets.– An operating budget is a budget for day-to-day

spending needs.– A capital budget is spending on major

investments.• Unlike the federal government, 49 states require

balanced budgets—budgets in which revenues are equal to spending.

Where are State Taxes Spent?Where are State Taxes Spent?

• Education– Every state spends taxpayer money to support at

least one public state university.– They also provide financial help to local governments

for public elementary and secondary schools.• Public Safety

– State police enforce traffic laws and help motorists in an emergency.

– State governments build and run corrections systems.• Public Welfare

– State funds support hospitals and clinics and unemployment benefits.

Where are State Taxes Spent?Where are State Taxes Spent?

• Highway and Transportation– State crews resurface roads and repair bridges.– States pay some of the cost of facilities like

waterways and airports.• Arts and Recreation

– States fund parks, nature reserves, museums, and art and music programs.

• Administration– State governments spend money to keep the

government running.– Revenues pay for state workers’ salaries.

State Revenue and Spending, 2004-2005State Revenue and Spending, 2004-2005

State Tax RevenueState Tax Revenue

• States receive most of their revenue through taxes.– Sales tax on goods and services is the main source of

state revenue.• Some goods, like food and clothing, are tax exempt in

certain states.– Even states without a sales tax impose excise taxes

that apply to specific products and activities.– Many states also collect an individual income tax,

which is paid in addition to the federal income tax.• Some states tax at a flat rate while other have

progressive rates.

State Tax Revenue, cont.State Tax Revenue, cont.

• Corporate income tax—Most states collect income taxes from corporations that do business in the state. – These taxes make up a small amount of state tax

revenues.• Other state taxes include:

– Licensing fees on certain businesses– Transfer taxes on stock certificates– Inheritance taxes– Property taxes, including real property and personal

property

Local GovernmentLocal Government

• Local governments, including towns, cities, countries, and school districts, carry major responsibilities in the public school systems, law enforcement, and fire protection.– They also manage public facilities, parks, and

recreation facilities.– They monitor public health, public

transportation, elections, record keeping, and social services.

Local Revenue and Spending 2007Local Revenue and Spending 2007

Local Government TaxesLocal Government Taxes

• Local governments levy property taxes, sales taxes, excise taxes, and income taxes.

• Many local taxes affect visitors and are designed to raise revenue from nonresidents.– Wall-to-wall traffic jams,

for example, are prompting a few cities to consider a congestion tax.