Chapter 13: Government Spending, Taxing, and National Debt

1. Chapter 13: Government Spending, Taxing, and National Debt

2. Size of Government • Government expenditures as a percentage of GDP have grown from 23% in 1960 to % in 199 • Expenditures of Federal government have risen from 17% to % of the GDP between 1960 and 199

3. Components of Government Expenditures • Government purchases of goods and services have remained stable at about 20% of the GDP in 1960-97 • Transfer payments have grown from 6% to 1% of the GDP over this period

4. Taxes • Tax revenues as a percentage of the GDP increased from 26% in 1960 to 30% in 1999 • Federal tax receipts rose from 18% to 20% of the GDP over this period

5. Role of Government: Public Goods • Non-rival in consumption: use by one person will not require loss of consumption by another person • Non-exclusive: no one can be excluded from consumption once it is produced • Free-rider problem: everyone uses regardless of tax payments

6. Role of Government: Externalities • Benefits and costs of one’s consumption and production to third parties • Positive externalities require government subsidies (college education) • Negative externalities require government taxes or regulations (pollution)

7. Positive Externalities: MSB>MPB Price MPC=MSC B P’ A P MSB MPB Quantity Q Q’

8. Negative Externalities: MSC>MPC Price MSC MPC B P’ P A MSB=MPB Q’ Q Quantity

9. Role of Government: Income Distribution • Progressive taxation and transfer payments to bridge income gap between the rich & poor • Horizontal equity: people with equal income pay equal amount of tax regardless the source of income • Vertical equity: people with higher income pay larger taxes

10. Incidence of Tax: Inelastic Demand Price S’ D S P2 Tax P1 Tax is paid by consumer: Forward shifting S’ D S Q1 Quantity

11. Incidence of Tax: Elastic Demand Price S’ S D D P Tax Tax paid by producer: Backward shifting S’ P1 S Q1 Q Quantity

12. Comparative Data • U.S. tax share of the GDP is 31.5% • It is the smallest among industrial nations • The highest share belongs to Denmark, 60%

13. Composition of Tax Receipts: 1950-2000 • Individual income tax share rose from 39.9 to 47.8% • Corporate income tax share fell from 26.5 to 10% • Social security tax share rose from 11 to 33.8% • Excise tax share fell from 19.1 to 3.7%

14. Effective Federal Income Tax Rates, 1996

15. Federal Budget Account ($ billions)

16. Public Debt • Government borrows money from investors through the issuance and sale of government securities or bonds • Investors hold the bonds for a certain time period to make interest income

17. Government Securities • Non-marketable securities • U.S. Savings Bonds & Notes: redeemable in cash for the face value after maturity • Marketable securities • Treasury bills (< 1 year; low interest rate) • Treasury notes (1-5 years) • Treasury bonds (> 5 years, high interest rate)

18. National Debt • Government borrowing to cover budget deficit • Debt id owed to • Private investors • Banks and financial institutions • Insurance companies • State & local governments • Foreign governments and private investors

19. Budget & Debt

20. Economic Effects of Federal Debt • Primary burden: opportunity cost of servicing the debt in terms of reduced public investment • Inflationary effect: higher interest rates and prices

21. Economic Effects of Federal Debt • Income distribution effect: income transfer from government to high income investors • Output effect: higher taxes and opportunity cost of productive investment