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Chapter 6
Taxes, Transfers, and Public Spending
Slide 6-2
Public school students often must pay supplemental fees in order to participate
in sports or other extra-curricular activities.
What accounts for this change in the way school operations are financed?
Introduction
Slide 6-3
Understand the key factors influencing the relationship between tax rates governments assess and the tax revenues governments collect.
Explain how the taxes governments levy on purchases of goods and services affect market prices and equilibrium quantities.
Learning Objectives
Slide 6-4
Analyze how Medicare affects the incentives to consume medical services.
Explain why increases in government spending on public education have not been associated with improvements in measures of student performance.
Understand how the Social Security system works and explain the nature of the problems it poses for today’s students.
Learning Objectives
Slide 6-5
Chapter Outline
Taxation from the Government’s Point of View
Taxation from the Point of View of Producers and Consumers
Public Spending and Transfer Programs
Social Security
Slide 6-6
Public schools were not widespread in the U.S. until the 1870’s?
State and local governments collect tax revenue from a variety of sources in order to subsidize public education?
Did You Know That...
Slide 6-7
Taxation from the Government’s Point of View
Three sources of government funding
– Fees, or user charges
– Taxes
– Borrowing
Slide 6-8
Taxation from the Government’s Point of View
The Government Budget Constraint
– The sum of public spending on goods, services, and transfer payments during a given period cannot exceed tax and fee revenues plus borrowed funds.
– Because borrowed funds must be paid from later taxes, the ability to collect tax revenue defines current spending limits.
Slide 6-9
The Tax Base
Tax Base
– The value of wealth or transactions subject to taxation
Slide 6-10
Tax Rates and Tax Revenues
Static tax analysis
– Based on the assumption that changes in the tax rate leave the tax base unaffected
Dynamic tax analysis
– Recognizes that higher tax rates may shrink the tax base
Slide 6-11
Tax Rates and Tax Revenues
If the disincentive effects of higher tax rates are small, static analysis may give a fairly accurate estimate of the change in tax revenues resulting from a tax rate change.
As tax rates escalate, members of the public have a greater incentive to remove their activities from the tax base. A dynamic analysis would be necessary to determine the overall effect on government revenues.
Slide 6-12
Maximizing Sales Tax Revenue
Figure 6-2
Slide 6-13
Taxation form the Point of View of Producers and Consumers
Excise taxes on gasoline become added costs of production.
This shifts the supply curve up by the amount of the unit tax.
Consequently, the equilibrium price of gasoline rises and the equilibrium quantity declines.
Slide 6-14
Effects of Excise Taxes on the Market for Gasoline
Figure 6-3
Slide 6-15
Who Pays the Tax?
The shapes of the supply and demand curves determine how the burden of a tax is split between producers and consumers.
In this example, consumers pays 30 cents of the tax and producers absorb the remaining 10 cents.
Slide 6-16
Public Spending and Transfer Programs
How taxes are spent
– Funding public goods
– Subsidize the consumption of merit goods
– Finance transfer payment programs such as Medicare
Slide 6-17
Medicare is a program that heavily subsidizes the medical expenses of those over 65.
– Currently the Medicare tax is 2.9 percent of earnings
– Retirees are guaranteed that the majority of their doctor’s and hospital bills will be paid with public monies
Publicly Subsidized Health Care: Medicare
Slide 6-18Figure 6-5
The Economic Effects of Medicare Subsidies
When the government pays a per-unit subsidy M for medical care, consumers pay the price Pd and providers receive Ps.
S
Q0Qm
PdD
P0
Ps
M
Slide 6-19
To increase the quantity of medical care, the government pays a subsidy
– The price per unit paid to medical service providers increases
– The price per unit paid by consumers falls
– More medical services are consumed
The Economic Effectsof Medicare Subsidies
Slide 6-20
Problems plaguing Medicare include
– rising physician incomes,
– the spread of private for-profit hospitals,
– and many new tests and procedures due to the rise in the price of medical services.
Expenditures are higher than projected because of rising prices and consumption.
Medicare Incentives at Work
Slide 6-21
Medicare Incentives at Work
Total spending on medical services consumes far more income than expected
– 14 percent of GDP in the United States
– The highest percent in the world
Patients consume many relatively low-value services that are very costly to provide
Slide 6-22
Today’s Challenge:Containing Medicare Spending
– Reimbursement caps limit total spending on specific procedures
– Patients are often discharged too soon
– Drugs are often withheld to cut costs
– Elderly patients are sicker than they otherwise would be
– Costs are often higher
Slide 6-23
Today’s Challenge:Containing Medicare Spending
Recent government policy has been to limit Medicare reimbursement to physicians.
As a result, a growing number of physicians now refuse to treat any Medicare patients.
Slide 6-24
Example: The Doctor is In, But Insurance is Out
A new type of health care clinic has emerged in response to the high costs of administering insurance claims.
These clinics do not accept any third-party payments, so they avoid all the paperwork associated with Medicare and insurance.
Slide 6-25
Example: The Doctor is In, But Insurance is Out
With overall costs much lower at these clinics, patients who are willing to pay out of their own pocket can purchase medical services at rates far below those charged by health care providers accepting third-party payments.
Slide 6-26
Economic Issues of Public Education
State and local governments provide primary, secondary, and post-secondary education at prices well below those that would otherwise prevail in the marketplace.
Slide 6-27
Economic Issues of Public Education
The performance of U.S. students compared with those in other countries declines at higher grade levels.
Subsidies, which drive a wedge between the cost of providing education and the price paid by the student, may account for this relatively poor performance.
Slide 6-28
Policy Example: Government Education Subsidies and Tuition Hikes
As the federal government subsidizes college students, each student is willing to pay a higher level of tuition.
This increase in demand for higher education has led to an increase in the average college tuition.
Slide 6-29
Social Security was created in 1935 to:
– Prevent retirees and those soon to retire from being destitute as a result of the Great Depression
– Transfer wealth between generations
– Guarantee minimum level of pension benefits to all persons
Social Security
Slide 6-30
The Ticking Social Security Time Bomb
The current Social Security payroll tax rate is 12.4 percent.
For Social Security and Medicare to be maintained at current levels, the payroll tax rate will have to rise to 25 percent within the first half of the 21st century.
Slide 6-31Source: Social Security Administration and author’s estimatesFigure 6-5
Private Rates of Return on Social Security Contributions
Slide 6-32
Social Security’s rate of return
– These were high to begin with because current retirees were paid benefits from growing membership.
– Later retirees collected less because membership growth slowed down.
– For today’s college students, negative returns are likely.
Social Security
Slide 6-33
Social Security’s rate of return
– High for low-income people
– Low for blacks
– Two-income earner families now get a much lower rate of return than one-income earner families
Social Security
Slide 6-34
The pre-funding myth
– Supporters of the current system argue that the system has built up assets
– The obligations of the system:• Benefits the system promises to pay• Taxes levied on the public over time
Social Security
Slide 6-35
Question– Given the promised level of benefits, does
it matter whether taxes required to pay the benefits are levied before, during, or after the benefits are paid?
Answer– No. The economic value of taxes now or
later must be exactly equivalent.
Social Security
Slide 6-36
How Social Security became the largest taxpayer drain and the most important domestic policy problem:
– In the 1970s the trust fund became very large.
– The World War II generation began to retire and Congress expanded benefits.
Social Security
Slide 6-37
Raise taxes
– Either increase the tax rate or expand the tax base
What Will it Take to Salvage Social Security?
Slide 6-38
What Will it Take to Salvage Social Security?
Reduce benefit payouts
– Increase the eligibility age
– Cut benefits to nonworking spouses
– Introduce means testing
Slide 6-39
What Will it Take to Salvage Social Security?
Reform immigration policies
Find a way to increase the rate of return on Social Security
Slide 6-40
Issues and Applications:Paying for School Activities
The amount of public subsidies to schools has dwindled in recent years.
Schools now seek to provide a lower level of service, because the “price” they receive for each service is lower.
Consequently, they have sought to remove the least valued services, unless those who use the services are willing to contribute.
Slide 6-41
Summary Discussion of Learning Objectives
The Relationship between Tax Rates and Tax Revenues– Dynamic tax analysis reveals how an increase in
the tax rate causes the tax base to decline.
How Taxes on Purchases of Goods and Services Affect Market Prices and Quantities– A tax collected from the seller of a good will shift the
supply curve up.
– To the extent that the price rises, the consumer bears a burden.
Slide 6-42
Summary Discussion of Learning Objectives
The Effect of Medicare on the Incentives to Consume Medical Services
– Medicare subsidizes the consumption of medical care.
– This subsidy encourages the use of medical services that are low in marginal value.
Slide 6-43
Summary Discussion of Learning Objectives
Why Bigger Subsidies for Public Schools Do Not Necessarily Translate into Improved Student Performance– The last unit of educational services
provided is likely to cost more than the benefit provided.
Slide 6-44
How Social Security Works and Why It Poses Problems for Today’s Students
– Social Security benefits are paid from current taxes.
– The current schedule of benefits for retirees will be an overwhelming tax burden for future generations.
Summary Discussion of Learning Objectives
End of Chapter 6Taxes, Transfers, and Public Spending
