TAXES & GOVERNMENT SPENDINGChapter 14

Section 1

What Are Taxes?

Government’s Authority to Tax We authorize the federal government,

through the Constitution and our elected representatives in Congress, to raise money in the form of taxes. Taxation is the primary way that the

government collects money. Taxes give the government the money it

needs to operate. The first power granted to Congress is the

power to tax, which is the basis of all federal laws.

Limits on the Government There are also limits on the

government’s power to tax. The purpose of a tax must be “for the

common defense and general welfare.” A tax cannot bring in money that goes to

individual interests. Federal taxes must be the same in every

state. The government cannot tax exports, only

imports.

Progressive Taxation Economists describe taxes based on

their structure and according to the tax base.

A progressive tax is a tax for which the percentage of income paid in taxes increases as income increases.

Other Types of Taxation A proportional tax is a tax for which the

percentage of income paid in taxes remains the same at all income levels.

A regressive tax is a tax for which the percentage of income paid in taxes decreases as income increases. A sales tax is regressive because higher

income households spend a lower proportion of their incomes on taxable goods and services.

Tax Bases Different taxes have different tax bases.

The individual income tax is based on a person’s earnings.

The corporate income tax is based on a company’s profits.

The property tax is based on real estate and other property.

The sales tax is based on goods and services that are sold.

Elasticities of Demand and Tax Effects

Taxes affect more than just the people who pay them.

Producers often pass on a portion of tax to consumers. Generally, the more inelastic the demand, the more

easily the seller can shift the tax to consumers.

Characteristics of a Good Tax Simplicity—tax law should be easy to

understand Efficiency—the tax should be able to be

collected without spending too much time or money

Certainty—it should be clear when the tax is due, how much is due, and how to pay the tax

Equity—the tax system should ensure that no one bears too much or too little of the tax

Determining Fairness Economists have proposed two different ideas

about how to measure the fairness of a tax. The benefits-received

principle holds that a person should pay taxes based on the level of benefits he or she expects to receive from the government.

The gasoline tax is an example of the benefits-received principle.

Determining Fairness, cont. The ability-to-pay principle holds that

people should pay taxes according to their ability to pay.

Good taxes generate enough, but not too much, revenue. Citizens needs are met, but not to such an extensive degree that the tax discourages production.

Section 2

Federal Taxes

Types of Federal Taxes Individual income taxes Corporate income taxes Social Security, Medicare, and

unemployment taxes Excise taxes and tariffs Estate and gift taxes

Individual Income Taxes The government’s

main source of revenue comes from the federal tax on individuals’ taxable income. What percentage

of federal revenues do not come from individual and corporate income taxes?

“Pay-As-You-Earn” Taxation The amount of federal income tax a

person owes is determined on an annual basis. To lessen the burden that one large yearly

tax would place on an individual and to make it possible for the government to meet its regular expenses, federal income tax is collected in a “pay-as-you-earn” system. This means that individuals usually pay most of

their income tax throughout the year as they earn income.

Tax Brackets The federal income tax is a progressive tax,

which rises with the amount of taxable income. Your range of income puts you in a specific tax

bracket. If you are single, at what rate would you pay taxes

on income over $29,500 and less than $71,950?

Withholdings and Tax Returns Employers help collect taxes by

withholding money from your paycheck based on an estimate of how much you will owe in federal income tax for that year.

After the calendar year ends, employers give their employees a report of how much income tax has already been paid. Employees then fill out a tax return to send

to the federal government.

Tax Returns, cont. On your tax

return, you figure out how much of your income is taxable. Taxable income is a

person’s total income minus exemptions and deductions.

Tax returns are due to the Internal Revenue Service by April 15.

Corporate Income Taxes Like individual income taxes, corporate

income taxes are progressive.

Determining corporate income taxes can be more difficult than determining an individual’s because businesses can take many deductions. Companies often deduct the cost of employee’s

health insurance as well as many other costs of doing business.

Social Security and Medicare Employees also withhold money to help

fund Social Security, Medicare, and unemployment insurance under the Federal Insurance Coalition Act (FICA). Most of the FICA taxes you pay go to Social

Security benefits for retired people, surviving members of wage earners, and disabled people.

The Medicare tax helps pay for health insurance for people over 65.

Unemployment The unemployment tax pays for

“unemployment compensation” that people can receive when they are laid off.

Other Types of Taxes Excise taxes—a general revenue tax on

the sale or manufacture of a good or service such as gasoline, cigarettes, and other items

Estate taxes—a tax on the total value of the money and property of a person who has died As of 2008, if the total value of an estate is

$2 million or less, there is no federal estate tax.

Other Types of Taxes, cont. Gift taxes—a tax on the money or

property that one living person gives to another The goal of the gift tax is to stop people

from avoiding the estate tax by giving away property before they died.

Import taxes—Tariffs, or import taxes, are taxes placed on imported goods.

Taxes that Affect Behavior The government

sometimes uses taxes to encourage good behavior, which is known as a tax incentive. Tax credits are often

used as an incentive. For example, people

who use solar power receive an income tax credit.

Section 3

Federal Spending

Federal Spending There are two types of government

spending.

Mandatory spending is money that Congress is required by existing law to spend on certain programs or to use for interest payments on the national debt.

Discretionary spending is spending about which lawmakers are free to make choices.

Federal Spending, cont. The federal

government spends the funds it collects from taxes and other sources on a variety of programs. Which are the

three largest categories of expenditures in the federal budget?

Entitlement Programs Most of the mandatory spending items are for

entitlement programs, which fund social welfare programs.

The federal government guarantees assistance for all people who quality for such programs.

Entitlements are a largely unchanging part of government spending. Congress can only change the eligibility

requirements or reduce benefits if there is a change in the law.

Social Security Social Security is a huge portion of federal spending.

About 50 million Americans receive monthly benefits from the Social Security Administration.

The future of Social Security is uncertain. As the millions of baby

boomers—people born after World War II—start to retire, the ratio of existing workers, who pay for Social Security, to retirees will fall.

Medicare and Medicaid About 42 million people receive Medicare benefits.

It pays for hospital care and for the costs of physicians and medical services.

Medicare costs have been rising as a result of expensive technology and people living longer. It faces the same problem as Social Security.

Medicaid benefits help low-income families pay for their medical expenses The federal government

shares the cost of Medicaid with state governments.

Other Mandatory Programs Other means-tested entitlements benefit

people and families whose incomes fall below a certain level. These entitlements include: Food stamps and child nutrition programs Retirement benefits and insurance for federal

workers Veterans’ pensions Unemployment insurance

In recent years, there has been a debate over governmentally funded universal healthcare.

Discretionary Spending Defense spending accounts

for about half of the government’s discretionary spending.

The Department of Defense uses this money to pay salaries of enlisted men and women as well as its civilian employees.

This money also buys weapons, missiles, ships, tanks, airplanes, and equipment.

Discretionary Spending, cont. The remaining discretionary funds go to

pay for the following: Education and training Scientific research Student loans Law enforcement Environmental cleanup Disaster relief

Federal Aid Federal taxes are sometimes used to help state

and local governments. State and federal governments share the cost of

Medicaid, unemployment insurance, education, lower-income housing, highway construction, and dozens of other programs.

States also rely on federal aid for disaster relief.

Section 4

State & Local Taxes & Spending

Local Governments How do local governments manage their

money? Local governments manage their money in

accordance with priorities set by elected local government officials.

Local governments create budgets and collect taxes just like the federal government.

State Budgets Governments plan their spending by creating a

budget. The federal government has one budget while

state governments have two budgets. An operating budget is a budget for day-to-day

spending needs. A capital budget is spending on major

investments. Unlike the federal government, 49 states require

balanced budgets—budgets in which revenues are equal to spending.

Where are State Taxes Spent? Education

Every state spends taxpayer money to support at least one public state university.

They also provide financial help to local governments for public elementary and secondary schools.

Public Safety State police enforce traffic laws and help motorists in

an emergency. State governments build and run corrections systems.

Public Welfare State funds support hospitals and clinics and

unemployment benefits.

Where are State Taxes Spent? Highway and Transportation

State crews resurface roads and repair bridges. States pay some of the cost of facilities like

waterways and airports. Arts and Recreation

States fund parks, nature reserves, museums, and art and music programs.

Administration State governments spend money to keep the

government running. Revenues pay for state workers’ salaries.

State Revenue & Spending, 2004-2005

State Tax Revenue States receive most of their revenue

through taxes. Sales tax on goods and services is the main

source of state revenue. Some goods, like food and clothing, are tax

exempt in certain states. Even states without a sales tax impose excise

taxes that apply to specific products and activities.

Many states also collect an individual income tax, which is paid in addition to the federal income tax. Some states tax at a flat rate while other have

progressive rates.

State Tax Revenue, cont. Corporate income tax—Most states

collect income taxes from corporations that do business in the state. These taxes make up a small amount of state

tax revenues. Other state taxes include:

Licensing fees on certain businesses Transfer taxes on stock certificates Inheritance taxes Property taxes, including real property and

personal property

Local Government Local governments, including towns,

cities, countries, and school districts, carry major responsibilities in the public school systems, law enforcement, and fire protection. They also manage public facilities, parks,

and recreation facilities. They monitor public health, public

transportation, elections, record keeping, and social services.

Local Revenue & Spending, 2007

Local Government Taxes Local governments

levy property taxes, sales taxes, excise taxes, and income taxes.

Many local taxes affect visitors and are designed to raise revenue from nonresidents. Wall-to-wall traffic

jams, for example, are prompting a few cities to consider a congestion tax.