Chapter 18 Public Finance: Expenditures and

TaxesCopyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

18-2

Government and the Circular Flow

(1) Costs

RESOURCEMARKET

PRODUCTMARKET

BUSINESSES HOUSEHOLDS

(4)Goods and services

(7)Expenditures

(8)Resources

(9)Goods and services

(4)Goods and services

(10)Goods and services

Net taxes(12)

Net taxes(11)

(3) Consumption expenditures(3) Revenues

GOVERNMENT

(2) Land, labor, capital

Entrepreneurial Ability

(2) Resources

(5) Expenditures (6) Goods and services

LO1

18-3

Government Finance

• Government purchases• Exhaustive

• Transfer payments• Nonexhaustive

• Borrowing and deficit spending• Opportunity cost is low during recession;

high during growth

LO2

18-4

Government Finance

19.6%

40

35

30

25

20

15

10

5

0 2012

1960

GovernmentPurchases

Governmenttransfer payments

22%

15.3%5%

Year

Perc

enta

ge o

f U.S

. out

put

Government purchases, transfers, and total spending as percentages of U.S. output, 1960 and 2012

LO2

18-5

Global Perspective

LO2

18-6

Federal Expenditures

LO3

18-7

Federal Tax Revenues

• Personal income tax• Progressive tax• Marginal tax rate

• Payroll taxes• Corporate income tax• Excise taxes

LO3

18-8

Federal Tax Revenues

(1)Total Taxable

Income

(2)Marginal Tax

Rate, %

(3)Total Tax

on HighestIncome inBracket

(4) Average Tax Rate on

Highest Income in Bracket % (3) / (1)

$1-$17,850 10 $ 1785 10

$17,851-$72,500 15 9983 14

$72,501-$146,400 25 28,458 19

$146,401-$223,050 28 49,920 22

$223,051-$398,350 33 107,769 27

$398,351-$450,000 35 125,847 28

$450,001 and above 39.6

Federal Personal Tax Rates, 2013*

* For a married couple filing a joint returnLO3

18-9

State Finances

LO4

18-10

Local Finances

LO4

18-11

Local, State, and Federal Employment

LO5

18-12

Apportioning the Tax Burden

• Size, distribution, and impact of the costs that taxes impose on society

• Benefits-received principle• Ability-to-pay principle

LO6

18-13

Apportioning the Tax Burden

• Progressive tax – average tax rates increase as income increases

• Regressive tax – average tax rate declines as income increases

• Proportional tax – average rate stays the same as income increases

LO6

18-14

Apportioning the Tax Burden

• Applications• Personal income tax: progressive• Sales tax: regressive• Corporate tax: proportional• Payroll tax: regressive

LO6

18-15

Tax Incidence and Efficiency Loss

• Tax incidence• Who really pays the tax?

• Excise tax• Tax burden depends on elasticity• Inelastic vs. elastic• Efficiency loss/deadweight loss• Transfer of surplus to government

LO7

18-16

Elasticity and Tax Incidence

Pric

e (P

er B

ottl

e)

Quantity(Millions of Bottles Per Month)

S

D

St

Tax $2

LO7

18-17

Elasticity and Tax Incidence

Elastic Demand Inelastic demand

Tax

a

b

c

a

b

0Q2

P1

Q1

P

Pe

Smaller efficiency loss with inelastic demand

St

S

De

Di

c

STax

St

P1

PPb

Q2 Q1

Pa

P

LO7

18-18

Elasticity and Tax Incidence

Elastic Supply Inelastic Supply

Smaller efficiency loss with inelastic supply

D D

S

SSt

St

P1Pa

PeP1

Pb

Pi

Q1Q2 Q1Q2

Tax Tax

aa

bb

c

c

0

P P

0 QQ

LO7

18-19

Efficiency Loss of a Tax

Pric

e (P

er B

ottl

e)

Quantity(Millions of Bottles Per Month)

S

D

St

Tax $2

Tax paidby consumers

5 10 15 20 25 Q

P

14

12

10

8

6

4

2

0

Tax paidby producers

Efficiency loss (ordeadweight loss)

LO7

18-20

Global Perspective

LO8

18-21

Probable Incidence of U.S. Taxes

Type of tax Probable Incidence

Personal income tax

The household or individual on which it is levied

Payroll taxes Workers pay the full tax levied on their earnings and partof the tax levied on their employers

Corporate income tax

Short Run: Full tax falls on owners of the businessesLong Run: Some of the tax may be borne by workers through lower wages

Sales tax Consumers who buy the taxed products

Specific excise taxes

Consumers, producers or both, depending on elasticities of supply and demand

Property Taxes Owners in the case of land and owner-occupied residences, tenants in the case of rented property, consumers in the case of business property

LO8

18-22

The U.S. Tax Structure

• The Federal tax system is progressive.• The state and local tax structures are largely

regressive• The overall U.S. tax system is progressive

LO8

18-23

Redistribution vs. Recycling

• Distribution of income• Taxes taken from the rich• Do they to flow to the poor?

• Shows income is transferred to the poor• Bottom 40% received more government

spending than they paid in taxes• Top 40% paid more in taxes than they

received in government spending

18-24

Redistribution vs. Recycling