16

Public Finance: Expenditures and Taxes

LO1

Government and the Circular Flow

(1) Costs

RESOURCEMARKET

PRODUCTMARKET

BUSINESSES HOUSEHOLDS

(4)Goods and services

(4)Goods and services

(3) Consumption expenditures(3) Revenues

(1) Money income (rents, wages, interest, profits)

(2) Land, labor, capital

Entrepreneurial Ability

(2) Resources

16-2

GOVERNMENT

(5) Expenditures

(7)Expenditures

(8)Resources

(6) Goods and services

(10)Goods and services

(9)Goods and services

Net taxes(12)

Net taxes(11)

LO1

Government Finance

• Government purchases• Exhaustive

• Transfer payments• Nonexhaustive

• Borrowing and deficit spending• Opportunity cost is low during

recession; high during growth

16-3

40

35

30

25

20

15

10

5

020091960

Year

Perc

enta

ge o

f U.S

. out

put

LO1

Government Finance

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

16-4

22% 20%GovernmentPurchases

5%15%

Governmenttransfer payments

LO1

Global Perspective

16-5

LO1

Federal Expenditures

16-6

LO1

• Personal income tax• Progressive tax• Marginal tax rate

• Payroll taxes• Corporate income tax• Excise taxes

Federal Tax Revenues

16-7

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-$16,750 10 $ 1,675 10$16,751-$68,000 15 9,363 14$68,001-$137,300 25 26,688 19$137,301-$209,250 28 46,834 22$209,251-373,650 33 101,086 27Over $373,650 35

Federal Personal Tax Rates, 2010*

* For a married couple filing a joint return

16-8

LO1

State Finances

16-9

LO1

Local Finances

16-10

LO1

Local, State, and Federal Employment

16-11

LO2

Apportioning the Tax Burden

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

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

16-12

LO2

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

16-13

LO2

Apportioning the Tax Burden

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

16-14

• 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

Tax Incidence and Efficiency Loss

LO3 16-15

Elasticity and Tax Incidence

14

12

10

8

6

4

2

0

5 10 15 20 25 Q

PPr

ice

(Per

Bot

tle)

Quantity(Millions of Bottles Per Month)

S

D

LO3 16-16

St

Elasticity and Tax Incidence

14

12

10

8

6

4

2

0

5 10 15 20 25 Q

PPr

ice

(Per

Bot

tle)

Quantity(Millions of Bottles Per Month)

S

D

LO3 16-16

Tax $2

St

LO3

Elastic Demand Inelastic Supply

b

b

0

P1

Q1

P

Smaller efficiency loss with inelastic demand

S

De

Di

S

P

Q1

P

Elasticity and Tax Incidence

16-17

b

StTax

aPe

Q2

cPa

b

StTax

aP1

Q2

cPb

LO3

Elasticity and Tax Incidence

0

P P

0 QQ

16-18

Smaller efficiency loss with inelastic supply

Elastic Supply Inelastic Supply

D D

S

S

bbP1

Q1 Q1

P1

Tax TaxSta

Pe

Q2

cPa

St

aaPi

Q2

cPb

LO3

Elasticity and Tax Incidence

0

P P

0 QQ

16-18

b

Smaller efficiency loss with inelastic supply

Elastic Supply Inelastic Supply

D D

S

S

bbP1

Q1 Q1

P1

Tax TaxSta

Pe

Q2

cPa

St

aaPi

Q2

cPb

LO3

Elasticity and Tax Incidence

0

P P

0 QQ

16-18

b

ax

Smaller efficiency loss with inelastic supply

Elastic Supply Inelastic Supply

D D

S

S

bbP1

Q1 Q1

P1

Tax TaxSta

Pe

Q2

cPa

St

aaPi

Q2

cPb

Efficiency Loss of a Tax

Pric

e (P

er B

ottle

)

Quantity(Millions of Bottles Per Month)

S

D

5 10 15 20 25 Q

P

14

12

10

8

6

4

2

0

LO3 16-19

St

Tax $2

Tax paidby consumers

Tax paidby producers

Efficiency loss (ordeadweight loss)

LO3

Global Perspective

16-20

LO3

Taxes fall on consumers, producers or both, depending on elasticity of supply and demand

Specific excise taxes

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 born by workers through lower wages

Sales tax Tax falls on consumers who buy the taxed products

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

16-21

LO4

• 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

Redistribution vs. Recycling

16-22

LO4

Redistribution vs. Recycling

16-23