Economics_-_New_Ways_of_Thinking

example, if Harry earns $30,000 a year and spends $32,000, he would have had to borrow $2,000. This $2,000 is Harry’s debt.

What is true for Harry is true for the federal government. If it spends more than it receives in tax revenues, it has to borrow the difference and incur a debt. Of course, another way to say this is that every time the federal government runs a deficit, it has to borrow money and incur a debt. In short, deficits lead to debt. The debt of the federal government is called the national debt.

As we stated earlier, the national debt as of October 24, 2005, was $8.009 trillion. If we divide the national debt by the U.S. population, we get per capita national debt, which is approximately $25,950. The per capita national debt is sometimes referred to as each “citizen’s share” of the national debt.

QUESTION: Will I have to pay off some of the national debt one day?

ANSWER: Whenever you pay federal taxes, you are helping to pay off the national debt. Remember, one of the spending categories of the federal government is “net interest on the national debt.” In 2005, this amounted to $177 billion. Whoever paid federal taxes that year helped pay off some of the national debt.

Higher Future Taxes

When the government spends more than it collects in tax revenues, it has to borrow the difference. Deficits lead to debt. But what does debt lead to? Some economists argue that it leads to higher taxes in the future.

When the government borrows the money to pay for the excess of its spending over tax revenues, it has to borrow that money from people. Those people will have to be repaid one day; the debt has to be paid off. (If you borrowed money from a bank, you would have to repay the money one day, with interest.) What happens when the government’s debt has to be paid off? Taxes must be used, so taxes have to be higher than they would have been had the debt not been incurred in the

first place. Some economists say that as far as future taxpayers are concerned, current budget deficits are a form of “taxation without representation.”

Suppose that in a particular year a government needs $2.0 trillion to buy all the different things that year, and to pay interest on its national debt. The government calculates that it would need only $1.9 trillion in taxes were in not for the interest on the debt. Taxpayers would be able to keep $0.1 trillion for themselves if the government had not gone into debt.

Is it ethical for one generation to buy things that another generation ends up partly paying for? Some people say no, but others say it depends on whether what the first generation buys benefits the next generation. For example, suppose the present generation decides to buy an interstate freeway system for $10 billion. The present generation decides to pay $2 billion itself through taxes and to borrow $8 billion. The present generation knows that the future generation will have to pay off the $8 billion (plus interest), but it reasons that the future generation will use the freeway system, so it should pay for some of it. If the current generation purchased $10 billion of something from which only it could benefit, the situation would be different.

If the government spends more than it takes in, it incurs a debt that must be paid off eventually. Do you think it’s fair to pass on to the next generation the responsibility for paying off this debt?

Tax Advantages

Globalization sometimes makes it easier for a company to lower its taxes. Firms might design a good in one country, manufacture

it in another, and sell it in a third. This approach gives these firms some flexibility in lowering their tax bills by shifting opera-

tions from country to country. For example, foreign subsidiaries of U.S. companies often report higher profits in low-tax countries and lower profits in hightax countries.

How do you expect the high-tax countries to respond to growing difficulties in col-

lecting taxes in a global economy?

Applying Economic

Concepts

6.Suppose the Fed were to create enough money to pay off the entire public debt. What would happen to prices? Explain your answer.

Chapter Summary

Be sure you know and remember the following key points from the chapter sections.

Section 1

The three main forms of federal taxes are personal income tax, corporate income tax, and Social Security tax.

Personal income tax is the tax a person pays on his or her income.

The tax corporations pay on their profits is the corporate income tax.

The Social Security tax is a tax placed on income generated from employment.

With a proportional income tax, everyone pays taxes at the same rate, whatever the income level.

With a progressive income tax, the form of income tax used in the United States, people pay at a higher rate as their income levels rise.

With a regressive income tax, people pay taxes at a lower rate as their income levels rise.

Section 2

The federal government breaks down its spending according to categories. The major categories include national defense; income security, retirement, and disability; Social Security and Medicare; and interest on the national debt.

According to economists, a government spending program is not worth pursuing unless the benefits of that program outweigh the costs; but the system of voting to decide on spending means costs of approved projects are sometimes greater than the benefits.

The government prepares a budget that indicates how it will spend its tax revenues.

Budget deficits occur when government expenditures exceed tax revenues; budget surpluses occur when revenues are greater than expenditures.

When the government borrows money to pay for excess spending, it has to borrow that money from people who will have to be repaid.

Economics Vocabulary

To reinforce your knowledge of the key terms in this chapter, fill in the following blanks on a separate piece of paper with the appropriate word or phrase.

1.A(n) ______ exists when government spending is greater than tax revenues.

2.A proportional tax is sometimes called a(n)

______ tax.

3.A tax rate that falls as income rises is a(n)

______ tax.

4.The ______ is the idea that each person should pay taxes according to his or her ability to pay.

5.The ______ is the idea that each person should pay taxes according to the benefits that he or she receives from government expenditures.

6.A gas tax is consistent with the principle of

______ taxation.

7.The ______ tax is applied to corporate profits.

8.A(n) ______ exists if federal government spending is less than federal government tax revenues.

9.A tax rate that rises as income rises is a(n)

______ tax.

Understanding the Main Ideas

Write answers to the following questions to review the main ideas in this chapter.

1.What are the three major types of federal taxes?

2.Which level of government—federal, state, or local—typically collects sales taxes?

3.Name two factors that have caused more and more people to pay the alternative minimum tax.

4.In what ways can a budget deficit be reduced or eliminated?

5.Explain how a budget deficit can cause a future generation to pay for what a current generation buys.

6.What did Adam Smith mean when he said, “What is prudence in the conduct of every private family, can scarce be folly in that of a great kingdom”?

7.What role does the Congressional Budget Office (CBO) play in the budget process?

8.What is the difference between a calendar year and a fiscal year?

9.What three federal taxes raise more than 90 percent of all federal tax revenues?

10.Smith paid $40,000 in federal income taxes, and Abuel paid $20,000. Is the income tax progressive, proportional, or regressive, or is it impossible to tell? Explain your answer.

11.Explain the benefits-received principle of taxation.

12.What is a flat tax?

Doing the Math

Do the calculations necessary to solve the following problems.

1.According to Exhibit 14-1, what percentage of total taxes is the personal income tax projected to account for in 2009?

2.According to Exhibit 14-5, approximately what percentage of a year did the representative taxpayer work to pay his or her taxes in 1980?

3.According to Exhibit 14-7, what percentage increase in government spending is expected between 2008 and 2009?

Solving Economic Problems

Use your thinking skills and the information you learned in this chapter to find solutions to the following problems.

1.Application. Suppose a local government were to lower the property tax from 1.25 percent of the assessed value of property to, say, 0.75 percent. How might this affect the price of property? Explain your answer.

2.Cause and Effect. Do you think a proportional tax or a progressive tax is more likely to lead to unequal after-tax pay? Explain your answer.

3.Writing. Write a one-page paper outlining your arguments either for or against the benefitsreceived principle of taxation.

4.Economics in the Media. Find an article in the local newspaper that addresses the current state of the federal budget, personal income

taxes, sales taxes, or the national debt. Identify the major ideas of the article.

Working with Graphs and Tables

1.Look at Exhibit 14-9(a) below. Each bar represents a certain type of federal income tax in 2005. Identify the kind of tax that goes with each bar.

2.Look at Exhibit 14-9(b). Each bar (A, B, and C) represents a certain federal spending program in 2005. Identify the program that goes with each bar.

E X H I B I T 14-9

20%

10%

(a)

0

(b)

Go to www.emcp.net/economics and choose Economics: New Ways of Thinking, Chapter 14, if you need more help in preparing for the chapter test.

What Is Government’s Role When It Comes to the Economy?

People often disagree as to what the federal government’s role should be regarding the economy. For example, some people argue that the federal gov-

ernment should try to stabilize the economy. These people say that if the economy is in a recession, the government should implement expansionary monetary and fiscal policy to stimulate the economy. This may mean increasing the money supply and cutting taxes to stimulate spending. Others argue that if the government hadn’t implemented the wrong monetary and fiscal policies in the past, there would be no recession to combat. The question becomes: does government mainly make the patient (the economy) sick, or does it mainly make the patient (the economy) well when it is sick?

Sometimes people disagree about what goods and services the federal government should provide to the citizens. Is it government’s role to deliver the mail and care for the sick and elderly, or is it better if government limited itself to building the roads and providing for the national defense? How much or how little should government do? Let’s listen in to what some people have to say.

Hamid Khatami, computer consultant

It seems to me that the Great Depression settled the issue of government’s role in the economy. I believe that if government hadn’t come to the rescue, and provided people with jobs, and stimulated spending in the economy, that the Great Depression

would have gone on much longer than it did.

Before the Great Depression, many people used to think that a free enterprise economy could take care of itself. It wouldn’t produce too much inflation and it wouldn’t bring on an economic contraction. Well, then, how do you explain the Great Depression? The unemployment rate rose to 25 percent during that time. The government had to do something.

Francine Watermaker, registered nurse

I’m not sure that Hamid has the explanation of the Great Depression correct. I don’t think it was free enterprise that failed. I think it was government doing the wrong things. It was the government overspending

in the 1920s and planting the seeds of the economic contraction. It was the government placing high tariffs on imported goods and making the contraction worse than it would have been. It was the Fed cutting the money supply too much. If anything, the Great Depression was a failure of government, not free enterprise. The way I see it, government makes more problems for the economy than it solves. Sure, the government can do some things right, but government today is into more things than it can do. I am in favor of the government limiting itself to doing what individuals or businesses can’t do. For example, I don’t believe that either individuals or businesses can supply the country with the national defense that it needs. National defense then should be left to government. Use the tax money to provide for the national defense, not to subsidize the farmers. And in my opinion, it doesn’t make sense for the government to be involved in programs such as Medicare

and Social Security.

Yong Kim, retired attorney

Here’s what I would like to know. If government is so bad—as Francine seems to imply—why has this country been as mil-

itarily and economically strong for so long? We have the largest economy in the world and we have the strongest and most capable military in the world. And we’ve done both of these things at the same time that the federal government has been getting bigger. If government bigness is so bad, how does someone explain that our economy is as strong and as big as it is?

Nancy Owens, college student

Ithink Yong is making a mistake here. Just because you see two things at the same

time, or nearly the same time, it doesn’t mean that one is the cause and the other is the effect. There are more dogs in the United States today than there were in 1950. Does it follow that a rising dog population is what causes the economy to be strong? Not at all. There are a lot of things that happen at around the same time that have nothing to do with each other.

But I have a better point to make with respect to Yong’s comment. Isn’t it possible that we would have an even stronger economy, and a mightier military, if the government hadn’t grown so large? With a smaller, less intrusive government, perhaps our economy would be even larger than it is today. And perhaps our military would be even stronger.

Blanca Sanchez, physician

Ithink what we are talking about here is that neither free enterprise nor govern-

ment is perfect at doing everything. Sometimes the free enterprise economy does need government to help it out. For instance, when the economy is slumping, or we need something that free enterprise won’t produce, such as protection against terrorists, government needs to step in.

But certainly this doesn’t mean that government has been perfect. Government can make mistakes. I think government can implement the wrong monetary policy— perhaps causing high inflation. I believe that government may implement a particular fiscal policy that doesn’t work because of, say, complete crowding out. My guess is that sometimes government does more to make things worse than to make things better.

Maybe what we are learning over time is what government should and should not do, and what free enterprise should and should not do. In other words, maybe the last 50 years have been a learning period for us.

What Do You Think?

1.What is your opinion as to the proper role for government, especially when it comes to economic issues?

2.What goods and services do you think government should provide (using taxpayer money)? Is there anything that government currently does that you don’t think it should do? Explain your answer.