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Chapter 10

Chapter 10. Introduction to Government Finance. $3 trillion annually. Federal, State, and Local Revenue. Sources: Taxes: Payroll Income (Corporate and Personal) Property Sales and Excise Estate Tariffs Fees Tuition Licenses . Purpose and Consequences of Government Finance.

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Chapter 10

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  1. Chapter 10 Introduction to Government Finance

  2. $3 trillion annually Federal, State, and Local Revenue • Sources: • Taxes: • Payroll • Income (Corporate and Personal) • Property • Sales and Excise • Estate • Tariffs • Fees • Tuition • Licenses

  3. Purpose and Consequences of Government Finance • Political Equilibrium • Market Equilibrium and Its Efficiency • The Distribution of Income

  4. Taxes Taxes are compulsory payments to government

  5. Tax Basics Tax Base • The item or activity that is to be taxed  • A general taxis one that taxes all of the components of the economic base, with no exclusions, exemptions, or deductions from the tax base. • A selective taxis one that taxes only certain portions of the tax base, or it might allow exemptions and deductions from the general tax base. An excise taxis a selective tax on the manufacture or sale of a particular good or service. Tax Rate Structure • The relationship between the amount that is to be paid in tax and the tax base for a given accounting period

  6. Tax Basics (Continued) Marginal Tax Rate The amount by which the tax increases when the tax base increases Average Tax Rate The total amount of tax divided by the total amount of the tax base • Tax bracket • The range of the tax base in which the marginal rate is constant

  7. Descriptors of the Tax Rate Structure • A Progressive Tax has astructure where the marginal tax rate is increasing and greater than the average tax rate. • A Proportional Tax has a structure where the marginal tax rate is constant and equal to the average tax rate. (Sometimes called a Flat Tax) • A Regressive Tax has a structure where the marginal tax rate is decreasing and less than the average tax rate.

  8. Figure 10.1 A Proportional Tax Rate Structure ATR = MTR t Tax Rate (Percent) 0 Tax Base (Dollars per Year)

  9. Figure 10.2 A Progressive Tax Rate Structure MTR 35 ATR 25 Tax Rate (Percent) 15 0 4,000 29,000 70,000 Tax Base (Dollars of Taxable Income per Year)

  10. Figure 10.3 An Example of a Regressive Tax Structure AT R MTR Ann ual Labor Earnings per W ork er 15.30 12.35 Tax Rate (Percent) 0 2.9 $76,200 $100,000

  11. Average Tax Rates in the US Average Tax Rates Tax Brackets (Taxable Income) Marginal Tax Rates (MTR) Beginning of Bracket End of Bracket 0-$4,000 0 0 0 $4000-$29,000 15 0 11 $29,000-$70,000 25 13 20 Above $70,000 35 20 34*

  12. Average Tax Rates Throughout the World

  13. How Should the Burden of Government Be Financed? Benefit Principle • Those who benefit the most from a particular program should pay the most for that program (Lindahl Tax principle at work). Ability-to-Pay Principle • Those who have the greatest ability to pay should be required to pay the most.

  14. Criteria for Evaluating Methods of Government Finance Equity • The distribution of the government finance burden should coincide with commonly held notions of fairness and ability-to-pay.  Efficiency • The system of government finance should raise revenues with the least loss in efficiency in the private sector.  Administrative ease • A government finance system should be relatively easy to administer consistently, without excessive costs to collect, enforce, and comply with taxes and tax laws.

  15. Horizontal and Vertical Equity • Horizontal equityis achieved when individuals of the same economic capacity (measured, for example, by income) pay the same amount of taxes per year (or over their lifetimes). • Vertical equityis accomplished when individuals of differing economic ability pay annual tax bills that differ according to some collectively chosen notion of fairness. • Both concepts are subjective. • “Economic capacity” is difficult to measure and administer. • “Ability to pay” requires value judgments on the proper income distribution.

  16. Tax Compliance, Avoidance and Evasion • Tax Evasion is the term forillegal ways to avoid paying taxes. It is typically the result of not declaring income or overstating otherwise legal deductions.  • Tax Avoidance is the term for legal ways to avoid paying taxes, typically the result of avoiding activities that are taxed, delaying the time at which taxes are owed, or taking an action designed to lower a tax burden.

  17. Figure 10.4 Reducing Tax Evasion A B MC MC Cost and Benefit Cost and Benefit E E 1 E2 MB1 = MTR1 MB = MTR MB2 0 D* 0 D* D* 2 1 Unreported Income per Year (Dollars) Unreported Income per Year (Dollars) C MC2 MC1 E Cost and Benefit E1 MB = MTR D* D* 0 2 1 Unreported Income per Year (Dollars)

  18. Alternatives to Taxation • Debt Finance is the means of financing expenditures by issuing bonds. • Inflationary Finance is the means of financing expenditures through the printing of money.

  19. Figure 10.5 Inflationary Finance T C I G2 A G1 Guns per Year B2 B1 T' 0 Butter per Year

  20. More alternatives to Taxation Donations • Money (but more usually time) is voluntarily given to government. Military service or work in the Peace Corps can be considered a donation when the compensation is less than the market value of the time.  User Charges • Users of a government service can expect to pay for that service. Examples include tuition, fees paid to enter state parks, greens fees at publicly owned golf courses. Earmarked Taxes • Taxes can be implemented to fund specific public goods. Examples include gasoline taxes and tolls designed to fund road and bridge repair.

  21. Figure 10.6 User Charges and Efficiency MSC Z* C* + S* S* Charges C* MSB = MPB + MEB Z MPB Q* 0 Trash Pickups per Year

  22. User Charges and the Transportation Infrastructure • Economists argue that voters demand better roads and airports in part because the price to use them (usually zero) is less than the true marginal cost (which should include congestion costs.)

  23. User Charges and Efficiency • Roads and Bridges wear out when too much weight is concentrated on too few axles. • Tolls motivate the wrong behavior in that they tax per axle rather than on pounds per axle. • Estimates suggest that taxing pounds per axle and using the revenue to create stronger roads would pay for itself more than eight-fold.

  24. Figure 10.7 User Charges for a Congestible Government-Supplied Service D2 = MSB2 MSC D1 = MSB1 User Charges (Cents per Mile) E* 20 E2 E1 N* 0 80 100 120 150 Vehicles per Mile per Hour

  25. Government Enterprise • Local Utilities • Lotteries

  26. State Lotteries • 38 states run or participate in lotteries. • State Lotteries account for more than 3% of state revenues. • People of varying incomes spend approximately the same amount on lotteries, which suggests that the lottery system is a regressive means of creating government revenue. • Lotteries pay out a smaller portion of revenue to winners than other forms of gaming (horse racing, casinos, etc.).

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