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McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
Public Finance: Expenditures and Taxes
12
12-2LO1
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
(1) Money income (rents, wages, interest, profits)
(2) Land, labor, capital
Entrepreneurial Ability
(2) Resources
(5) Expenditures (6) Goods and services
12-3LO1
Government Finance
• Government purchases
• Exhaustive
• Transfer payments
• Nonexhaustive
• Borrowing and deficit spending
• Opportunity cost is low during recession, high during growth
12-4
20%
40
35
30
25
20
15
10
5
0 2010
1960
GovernmentPurchases
Governmenttransfer payments
22%
15%5%
Year
Per
cen
tag
e o
f U
.S. o
utp
ut
LO1
Government Finance
Government purchases, transfers, and total spending as percentages of U.S. output
12-5LO1
Global Snapshot
12-6LO1
Federal Expenditures
Pensions & income security
38%
All other12%
National defense
20%
Health24%
Interest on public debt6%
Payroll taxes40%
Excise taxes3%
All other6%
Corporate income tax
9%
Federal expenditures: $3456 billion Federal tax revenues: $2162 billion
12-7LO1
• Personal income tax
• Progressive tax
• Marginal tax rate
• Payroll taxes
• Corporate income tax
• Excise taxes
Federal Tax Revenues
12-8
Federal Tax Revenues
LO1
(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–$17,000 10 $ 1700 10
$17,001–$69,000 15 9500 14
$69,001–$139,500 25 27,125 19
$139,501–$212,300 28 47,509 22
$212,301–$379,150 33 103,570 27
Over $379,150 35
Federal Personal Tax Rates, 2011*
* For a married couple filing a joint return
12-9
State and Local Finance
• State revenues
• 48 percent from sales and excise taxes
• 40 percent from personal and corporate taxes
• License fees and other taxes make up the rest
LO1
12-10
State and Local Finance
• State expenditures• 37 percent on education• 28 percent on public welfare• 8 percent on health and hospitals• 7 percent on highway maintenance
and construction• 4 percent on public safety• 20 percent on other purposes
LO1
12-11
State and Local Finances
• Local finances• 71 percent of revenues from property taxes• 17 percent of revenues from sales and
excises taxes• 44 percent of expenditures on education• 12 percent on welfare, health, and
hospitals• 11 percent on public safety• 11 percent on housing, parks, and
sewerage • 6 percent on streets and highways
LO1
12-12
Local, State, and Federal Employment
• State and local jobs• 50 percent in education• 9 percent in hospitals or health care• 10 percent in police and corrections
• Federal jobs• 50 percent in national defense or postal
service• 12 percent in hospitals or health care• 4–7 percent in natural resources, police,
and financial administrationLO1
12-13LO2
Apportioning the Tax Burden
• Size, distribution, and impact of the costs that taxes impose on society
• Benefits-received principle
• Ability-to-pay principle
12-14LO2
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
12-15LO2
Apportioning the Tax Burden
• Applications
• Personal income tax: progressive
• Sales tax: regressive
• Corporate tax: proportional
• Payroll tax: regressive
12-16
• Tax incidence
• Who really pays the tax?
• Excise tax
• Tax burden depends on elasticity
• Inelastic versus elastic
• Efficiency loss
• Deadweight loss
• Transfer of surplus to government
Tax Incidence and Efficiency Loss
LO3
12-17
Elasticity and Tax Incidence
14
12
10
8
6
4
2
0
5 10 15 20 25 Q
PP
rice
(p
er b
ott
le)
Quantity(millions of bottles per month)
S
D
St
Tax $2
LO3
12-18LO3
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
S
Tax St
P1
PPb
Q2 Q1
Pa
P
Elasticity and Tax Incidence
12-19
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
LO3
Elasticity and Tax Incidence
0
P P
0 QQ
12-20
Efficiency Loss of a Tax
Pri
ce (
per
bo
ttle
)
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)
LO3
12-21LO3
Global Snapshot
12-22LO3
Type of tax Probable Incidence
Personal income tax
Tax falls on 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 Tax falls on consumers who buy the taxed products
Specific excise taxes
Taxes fall on consumers, producers, or both, depending on elasticity of supply and demand
Property Taxes Taxes fall on owners in the case of land and owner-occupied residences, tenants in the case of rented property, consumers in the case of business property
Probable Incidence of U.S. Taxes
12-23
U.S. Tax Structure
• Federal tax system is progressive
• State and local tax structures are largely regressive
• Overall U.S. tax system is progressive
LO3