Deficits , Surpluses , and the National Debt

1. Deficits,Surpluses,and theNational Debt

2. Tax his car, • Tax his gas, • Find other ways • To tax his ass • Tax all he has • Then let him know • That you won't be done • Till he has no dough. • When he screams and hollers, • Then tax him some more, • Tax him till • He's good and sore. • Then tax his coffin , • Tax his grave, • Tax the sod in • Which he's laid. • Put these words • upon his tomb, • " Taxes drove me to my doom..." • When he's gone, • Do not relax, • Its time to apply • The inheritance tax. • Utility Taxes • Vehicle License • Registration tax • Vehicle Sales Tax • Watercraft • Registration Tax • Well Permit Tax • Accounts Receivable Tax • Building Permit Tax • CDL license Tax • Cigarette Tax • Corporate Income Tax • Dog License Tax • Excise Taxes • Federal Income Tax • Federal Unemployment Tax (FUTA) • Fishing License Tax • Food License Tax • Fuel Permit Tax • Gasoline Tax (42 cents per gallon) • Hunting License Tax • Inheritance Tax • Gross Receipts Tax • Inventory Tax • IRS Interest Charges IRS Penalties (tax on top of tax) • Liquor Tax • Luxury Taxes • Workers Comp Tax • Marriage License Tax • Medicare Tax • Personal Property Tax • Property Tax • Real Estate Tax • Service Charge Tax • Social Security Tax • Road Usage Tax • Sales Tax • Recreational Vehicle Tax • School Tax • State Income Tax • State Unemployment Tax (SUTA) • Telephone Federal Excise Tax • Telephone Federal Universal Service Fee Tax • Telephone Federal, State and Local Surcharge Taxes • Telephone Minimum Usage Surcharge Tax • Telephone Recurring and Non-recurring Charges Tax Taxes We Didn’t Have 100 Years Ago • Tax his land, • Tax his bed, • Tax the table • At which he's fed. • Tax his tractor, • Tax his mule, • Teach him taxes • Are the rule. • Tax his cow, • Tax his goat, • Tax his pants, • Tax his coat. • Tax his ties, • Tax his shirt, • Tax his work, • Tax his dirt. • Tax his tobacco, • Tax his drink, • Tax him if he • Tries to think. • Tax his cigars, • Tax his beers, • If he cries, then • Tax his tears. • Telephone State & Local Tax • Telephone Usage Charge Tax • Utility Taxes

3. Chapter Objectives: 1. Explain the difference between the budget deficit and public debt. 2. Explain each of the three budget philosophies. A. Annually balanced budget B. Cyclically balanced budget, and C. Functional Finance 3. Identify the principal causes of the public debt. A. Wartime financing B. Fighting recessions C. Tax cuts D. Lack of political will 4. Describe the annual interest chargeson the debt, who holds the debt and the impact of accounting and inflation on the debt. 5. State the absolute sizeof the debt and the relative sizeas a % of GDP. 6. Explain why the debt can also be consideredpublic credit. 7. Identify and explain two widely held myths about the public debt. A. Going bankrupt B. Burden on our grandchildren 8. Explain the effect of the debt on income distributionand Ig. 9. Explain how thedebt[& higher interest rates]mightdecrease net exports. 10. Explain 3 proposed remedies to reduce or to eliminate budget deficits. Budget Deficits and the National Debt And the concept of “crowding-in”

4. "Crowding Out" and "Crowding In"

5. [Incr G incr I.R. Decr Ig] "Crowding-out" Effect DI 10% 8% 6% 4% 2% Loanable Funds Market PL Real I.R. s D2 AS D1 AD2 AD1 4% 2% G 10% Realinterest rate Crowding Out Effect 6% IG YR Y* F2 F1 5 10 1520 25 15 0 Quantity of LF Investment (billions of dollars) In this case, it would be 100% “crowding out”. G can finance a deficit by: 1. Borrowing - this raises interest rates in the LFM and “crowds out” investment. 2. Money Creation- no “crowding out” so is more expansionary than borrowing. Friedman Just follow the “monetary rule.”

6. THE “CROWDING In” EFFECT DI2 16 14 12 10 8 6 4 2 0 AS DI1 AD2 AD1 G Y* YR Real interest rate (%) 5 1015 20 25 30 35 40 Investment (billions of dollars) But … if the economy is operating well below its potential, increased government spending could result in more jobs, more positive profit expectations, and a “crowding in” of Ig.

7. How “Crowding In” Might Work “Crowding In” – potential for G spending to stimulate private investment in an otherwise sluggish economy. “Crowding Out”represents argument forpassive fiscal policy. “Crowding In” would be an argument for active fiscal policy. If the economy is operating well below its potential, the additional fiscal stimulus provided by deficit spending could encourage firms to invest more. A G deficit could stimulate a weak economy, increasing AD & putting a“sunny face on business expectations.”As business expectations grow more favorable, firms could become more willing to invest. [thus, “crowding in” of investment] If you have ever approached a crowded restaurant, you may not have wanted to put up with the hassle of a long wait and were thus “crowded out.” Similarly, large G deficits may drive up interest rates and crowd out some investment. As Yoga Berra would say, “No one goes there any more. It’s too crowded.” Yoga also said, “If you come to a fork in the road, take it.” On the other hand, did you ever pass up a restaurant because the place seemed dead-it had few customers. Perhaps you wondered why so few people chose to eat there. With just a few more customers, you might have been willing to “crowd in.” Businesses may be reluctant to invest in a lifeless economy. Economic stimulus could encourage them to “crowd in.”

8. Annually Balanced Budget • Cyclically Balanced Budget • Functional Finance Three Budget Philosophies

9. [A. Annually Balanced; B. Cyclically Balanced; C. Functional Finance] Three Budget Philosophies “G” Economy “Earth Orbits Sun” Annually Balanced Budget – each time the earth orbits the sun we should balance the budget. This would put the G in an economic straitjacket as we couldn’t fight recessions with deficit spending. This would be like pouring water on a drowning man. We usedto worship at the alter of a balanced budget prior to the Great Depression. 49 states require this. Balancing the budget during a recession wouldnot be counter-cyclical, but pro-cyclical. Increasing taxes during a recession would worsen the recession. Running asurplus during boomtimes and giving the money back would be inflationary.

10. Balancing the Budget – during Recession [Increase Tor Decrease G - Procyclical AD1 Cut AS AD2 AD3 So, the fiscal actions to balance the budget decreases, rather than increasesAD, and is procyclical, not counter. PL1 PL2 PL3 YR YR Y*

11. Balancing the Budget - during Inflation [Decrease T or Increase G - Procyclical] AS AD3 AD2 AD1 PL3 PL2 So,thefiscal actions to balance the budget increase, rather than decrease AD, & is also procyclical, rather than counter. PL1 YI Y* YI

12. Inflation “Raise taxes” 2. Cyclically Balanced Budget Tax Cuts Raise Taxes Recession “Tax cut” “Balanced” “DeficitSpending” Cyclically Balanced Budget – run deficits during recessions & surpluses during expansionsso the budget is balanced not each year but over the course of the business cycle. Economic wisdom tells us we should have deficits in lean years and surpluses in fat years. There is nothing “sacred about 12 months asan accounting period.” The government could conduct counter-cyclical fiscal policy and balance its budget over a period of years. The basic problem of this philosophy is that fluctuations are not usually symmetrical enough to ensure that the surplus will offset the deficit.

13. 3. Functional Finance U.S. Economy “Balance the economy, not the budget.” Functional Finance – balance the economy not the budget. The annual or cyclically balanced budget is of secondary importance. The important thing is to provide for non-inflationary, FE & ensure the economy produces its potential GDP. If there are chronic deficitsor surpluses, so be it. Deficits are minor problems, compared to inflation or recessions.

14. The “Debt”and the“Deficit” $9.4 tril. Flow ($162 bil.) Reasons for Debt 1. Lack of political will 2. Tax cuts 3. Recessions (transfers) 4. Wartime financing Stock ($9.4 trillion) [ADD] Attention Deficit Disorder Congressmen have trouble focusing attention on the deficit. $9.4

15. $33,000 $9.4 Trillion Debt Per Capita 3 3, 9, 4 140, The Debt is increasing by $1 million per minute. $1.58 billion per day is being added to the debt.

16. The National Debt Since 1970

17. The Federal Budget Deficit

18. Sources of Government Revenue 1863 Yea! We don’t have to pay any federal income or SS taxes.

19. Sources of Government Revenue - 2006 We are paying about $1 trillion in taxes. 7% $179 B Three major sources of federal taxes(90%) a. Individual income taxes b. Social Insurance c. Corporate income taxes 37% $884 bil. 11% $261 B 45% $1,096 Deficit $248 bil.

20. 2008 Federal Budget Proposal-$2.9 Tril. Agriculture 90.9 Interest [$243] Commerce 6.7 Defense 527.6 Education, job train. 62.6 Energy, Environment 21.6 Health/Human SVC699.0 Homeland Security 34.6 Housing/Urban Dev. 36.2 Interior 10.1 Justice, Law enforce 23.3 Labor 50.4 NASA 17.3 SEC & Exchange Com. 8.5 Corp Engineers 4.8 State 37.4 Social Security 655.5 Transportation 67.3 Legislative Branch 4.8 Treasury 525.5 Judiciary 6.7 Veteran’s Affairs 84.4 Other agencies 148.7 $67.3

21. Federal Spending in 2007, by Function

22. DEFICITS,SURPLUSES,ANDDEBT • Definitions: • Budget Deficit [G >T] • Budget Surplus [T >G] • National or Public Debt • U.S. Securities

23. 1. Progressive2. Proportional3. Regressive Three Types of Taxes

24. Flat Tax on Income: same % of income, different amounts, so Proportional Flat Tax on Products: same amount, different % of income, so Regressive 35% 33% 28% Marginal Tax Rates Progressive – takes a larger % from high income groups 25% 15% 10% Single - no tax on 1st $7,825 I only have to pay the FICA tax. 28% 25% 10% 15% 33% 35% $357,700+ $78,850 $7,825 $32,550 $164,550 $357,700 0 Standard Deduction [$5,350-dependent] [$15,650-married filing jointly] [7,825-single] [$11,200-HH]

25. Our Progressive Tax System Is Like ALayeredCake 35% over $357,700 33% up to 357,700 28% up to $164,550 25% up to $78,850 15% up to $29,700 10% up to $16,050 No tax on 1st $7,825

26. Proportional& Regressive Taxes Proportional – takes same 20% [not amount] from all income groups 20% Example: Medicare – 1.45% on all income earned. $100,000 $50,000 $40,000 $30,000 Pay $20,000 Pay $10,000 [So, not same amount but same %, 20%] Take that, you “low incomer.” 30% Regressive– takes a larger % from low income groups 20% Example: Sales Tax I’m a “low incomer.” 10% $40,000 $50,000 $30,000

27. What kind of taxes are these? Flat Tax on Income: same % of income, differentamounts, soproportional. Flat Tax on Product: same amount, different % of income, soregressive. Toll Road($1 per day) $10,000 $50,000 $200$200 2% .4% Flat Tax on Cigarettes[Excise][$1.41 cents pack] [1 pack day][1 pack day] $10,000 $100,000 $515$515 5% .5% Addicted State 6.25% Excise Tax on Two Identical $20,000 Autos BOMO $10,000 $100,000 $1,250$1,250 12.5% 1.25%

28. What kind of taxes are these? Flat Tax on Income: same % of income, different amounts, soProportional Flat Tax on Products: same amount, different % of income, soRegressive Property Tax of 2.5% on $100,000 Houses $25,000 $50,000 [100,000 house] [$100,000 house] $2,500$2,500 10% 5% $100 Spent On The Lottery $20,000 $100,000 [$100 Lottery] [$100 Lottery] 5%.1% “The lottery tax is avoluntary regressivetax on morons.” What about the .20 a gallon gasoline tax? So – all of these taxes wereregressive. I played the lottery.”

29. TAX RATE TAX RATE State (Cents per pack) Rank State (Cents per pack) Rank Alabama(1) 16.5 47 Nebraska 64 24 Alaska 200 4 Nevada 35 39 Arizona 200 4 New Hampshire 52 32 Arkansas(20) 59 26 New Jersey 258 1 California 87 19 New Mexico 91 18 Colorado 20 43 New York (1) 150 5 Connecticut 200 3 North Carolina 30 45 Delaware (3) 24 41 North Dakota 44 34 Florida 33.9 40 Ohio 55 29 Georgia 37 36 Oklahoma 23 42 Hawaii (30 130 7 Oregon 128 8 Idaho 57 27 Pennsylvania 100 12 Illinois (1) 98 17 Rhode Island 246 2 Indiana 55.5 28 South Carolina 7 51 Iowa 36 37 South Dakota 53 31 Kansas 29 20 Tennessee (1)(2) 20 48 Kentucky (2) 30 46 Texas 141 11 Louisiana 36 37 Utah 69.5 23 Maine 200 3 Vermont 119 10 Maryland 100 12 Virginia (1) 30 47 Massachusetts 151 4 Washington 203 3 Michigan 200 5 West Virginia 55 29 Minnesota 48 33 Wisconsin 77 21 Mississippi 18 49 Wyoming 60 25 Missouri (1) 17 50 Dist. Of Columbia 100 12 Montana 170 6 U.S. Median 90 State Excise Tax on Cigarettes Counties & cities may impose an additional tax on a pack of cigarettes. Also, the federal tax is 39 cents. NYC has an additional $1.50 for a total cigarette pack price of $7.50. 30 states have increased cigarette taxes since January 1, 2002 some twice. Every 10% increase reduces youth smoking by 7% and adult smoking by 2%.

30. If you inherit $2 million dollars this year, how much do you get to keep? The Estate Tax

31. Estate Tax [taxes on inheritances] The Federal Estate Tax is disappearing. An estate is exempt from federal estate taxes if it’s below the following thresholds. The Tax will disappear in 2010, only to reappear in 2011. [tax of 55% on estates after the first million] $2 M tax free 2007 $2 M tax free 2008 $3.5 M tax free 2009 2010 No estate tax 2011 $1 M tax free If you live in one of the gold states, you might owe additional estate or inheritance taxes, even after the federal G’s death tax disappears.

32. 2006 Expenditures of $2.654 Revenues of $2.407 [Deficit of $248] Last Surplus

33. Causes of the National Debt Facts & Figures: Financial Price Of War Total Cost per ConflictCostPerson WW1 $125 bil. $2,489 WWII $600 bil. 20,388 Korea 336 bil. 2,266 Vietnam 494 bil. 2,204 Gulf War I 76 bil. 306 Gulf War II 438 bil.* 536 *Cost over $12 billion amonth Causes: • Wars • Recessions • Tax Cuts • No political will 300,000 from the Afghanistan-Iraq wars suffer from PTSD [Post-Traumatic Stress Disorder] or major depression that will cause the nation over $6 billion over two years. The War in Iraq has cost $16,000 per family.

34. Historical Record of the Marginal Tax Rate 91% on income over $200,000 91% 35% 2008

35. Medicare tax– 1.45% for an individual [2.9% for self employed] for every dollar earned. Harrison Ford – received $25 million for 20 days work on a movie. 1.45% of $25 million = $362,500 x 2 = $725,000medicare tax. [Over his 35 years on the Big Screen, his films grossed over $10 bil. Jim Carrey – gets $20 million per movie, so his tax is $580,000. [1.45% of $20 million = $290,000 x 2 = $580,000.] Top Marginal Tax Rates YearTax Rate 1900 No Tax 1914 1% [over $3,000] [Only 1 in 270 paid this tax at all] 1930 30% [1 in every 32 was now paying taxes] 1940 81% [1 in every 3 was paying taxes] 1943 *Paycheck withholding (by the boss) was launched to stop cheating. 1950 [over $200,000] 91% 1970 70% [Everyone was paying with taxable Y] 1980 70% 2000 39.6% 200835% Marginal Tax Rate 1913-2008 [91% for dollars over $200,000]

36. Government Finance GLOBAL PERSPECTIVE Total Tax Revenue – Selected Nations Percent of Total Output-2004 10 20 30 40 50 Sweden Denmark Norway Finland France Italy United Kingdom Germany Canada Australia United States Japan South Korea 50.7 49.6 44.9 44.3 43.7 42.2 36.1 34.6 33.0 31.6 25.4 25.3 24.6 Source: Organization for Economic Cooperation and Development

37. Percent Federal Income Tax Paid by Different Income Percentiles 100% 90% 80% 70% 60% 40% 30% 20% 10% 97% 134 million filed tax returns but only 90 million paid any taxes. Our average tax rate was 14%. 85% 68% 57% $61,000 and over $30,000 and over 37% $99,000 and over $137,000 + $328 000 + 3.3% Bottom 5% Top 25% Top 50% Top 1% Top 5% Top 10%

38. Let's Demonstrate Our Tax System In The Real World • Suppose that every day, ten men go out for beer and the bill for all ten comes • to $100. If they paid their bill the way we pay our taxes, it would go like this: • The first four men (the poorest) would pay nothing. • The fifth would pay $1. • The sixth would pay $3. • The seventh would pay $7. • The eighth would pay $12. • The ninth would pay $18. • The tenth man (the richest) would pay $59. So, that's what they decided to do. The ten men drank in the bar every day and seemed quite happy with the arrangement, until one day, the owner threw them a curve. 'Since you are all such good customers, he said, 'I'm going to reduce the cost of your daily beer by $20. Drinksfor the ten nowcost just $80. The group still wanted to pay their bill the way we pay our taxes so the first four men were unaffected. They would still drink for free. But what about the other six men - the paying customers? How could they divide the $20 windfall so that everyone would get his'fair share?' They realized that $20 divided by six is $3.33. But if they subtracted that from everybody's share, then the fifth man and the sixth man would each end up being paid to drink his beer.

39. So, the bar owner suggested that it would be fair to reduce each man's bill by roughly the same amount, and he proceeded to work out the amounts each should pay.!  And so:The fifth man, like the first four, now paid nothing (100% savings). • The sixth now paid $2instead of $3 (33%savings). • The seventh now pay $5 instead of $7 (28%savings). • The eighth now paid $9 instead of $12 (25% savings) • The ninth now paid $14 instead of $18 (22% savings) • The tenth now paid $49 instead of $59 (16% savings). • Each of the 6 was better off than before. And the first 4 continued to drink for free. • But once outside the restaurant, the men began to compare their savings.'I only got a dollar out of the $20,'declared the sixth man. He pointed to the tenth • man,' but he got $10!‘ • 'Yeah, that's right,' exclaimed the fifth man. 'I only saved a dollar, too. It's unfair that • he got ten times more than I!‘ • 'That's true!!' shouted the 7th man. 'Why should he get $10 back when I got only two? • The wealthy get all the breaks!''Wait a minute,' yelled the first four men in unison. 'We • didn't get anything. The system exploits the poor!'The nine men surrounded the tenth and beat him up. • The next night the tenth man didn't show up for drinks, so the nine sat down and had • beers without him. When it was time to pay the bill, they discovered something important. • They didn't have enough money between all of them for even half of the bill!And that is how our tax system works. • The people who pay the highest taxes get the most benefit from a tax reduction. Tax them • too much, attack them for being wealthy, and they just may not show up anymore. In • fact, they might start drinking overseas where the atmosphere is somewhat friendlier.

40. STATE AND LOCAL FINANCE State Expenditures Education Public Welfare Health and Hospitals Highways [.20 a gallon] Public Safety Education 36% Health & Hospitals 8% Public Welfare 25% Highways 8% All Other 18% Public Safety 5%

41. Federal Expenditures Pensions and Income Security National Defense Health Interest on Public Debt Pensions & Income Security 35% Total Expenditures $2,654 Billion National Defense 20% All Other 15% Health 21% Interest 10% 2006 Data

42. Federal Tax Revenues Personal Income Tax Payroll Tax Corporate Income Taxes Excise Taxes Total Tax Revenues $2,407billion Personal Income Tax 46% Excise Taxes 4% Payroll Taxes 38% All Other 4% Corporate Income Tax 8% 2006 Data

43. STATE AND LOCAL FINANCE State Revenues Sales and Excise Tax Personal Income Tax Corporate Income Tax Licenses and Others Property Taxes & Other Taxes Sales & Excise Taxes 48% State Personal Income Tax 34% Property Taxes & Other Taxes 5% Corporate Income Tax 7% Licenses & Others 6%

44. States with No Income Tax (Red) *They tend to have more regressive tax systems.

45. State, City, and County Sales Tax

46. State Sales Tax

47. STATE AND LOCAL FINANCE Local Revenues Property Taxes Sales and Excise Taxes Personal & Corporate Income Taxes Property Taxes 74% Sales & Excise Taxes 16% Personal & Corporate Income Taxes 6% All Other 4%

48. National Debt History $9.4 Tril.

49. National Debt History[adjusted for inflation in 2000 dollars] $9.4 Tril. Except for WWII, the deficit stayed pretty constant for about 40 years until 1983

50. Who Owns Most of the National Debt?