Chapter 14: Taxes and Government Spending

Taxes and Government Spending

Taxes

• Taxes pay for public goods.
• Three types of tax structures exist.
• There are characteristics of a good tax.
• Consideration of who bears the burden of a tax.

Funding Government Programs

• Citizens authorize the government, through the Constitution and elected officials, to raise money through taxes.
• Taxation is the government’s primary source of revenue and is used to provide public goods.

Taxes and the Constitution

The Power to Tax

• The power to tax is first outlined in Article I, Section 2 of the Constitution.
  • "Representatives and direct Taxes shall be apportioned among the several States which may be included within this Union, according to their respective Numbers…"
• The 16th Amendment (1913) of the Constitution gives the federal government the power to tax individual income.

Limits on the Power to Tax

• Must be for “the common defense & general welfare.”
• Federal taxes must be the same in every state.
• No tax on exports or churches.

Tax Bases and Tax Structures

• A tax base is the income, property, good, or service that is being taxed.
• Types of taxes:
  • Proportional tax: Percentage of income paid is equal at all income levels. Example: sales tax.
  • Progressive tax: Percentage of income paid in taxes increases as income increases. Example: income tax.
  • Regressive tax: Percentage of income paid in taxes decreases as income increases. Example: Social Security tax.

Characteristics of an Effective Tax

1. Simple: Easily understood by taxpayers and tax collectors. Clearly explains when and how much is due.
2. Efficient: Easy to administer and successful at generating revenue.
3. Equity: Impartial and just, with restrictions on tax “loopholes.”

Two Principles of Taxation

• Benefits-Received principle: Taxes are based on the level of benefits received (proportional taxes).
  • Example: If a tax is placed on gas, those who buy more gas will naturally provide most of the tax’s revenue.
• Ability-To-Pay principle: Taxes are based on the level of income (progressive taxes).
  • Example: Since Jeff Bezos has the ability to pay a higher tax than most Americans, he should.

Federal Taxes

Topics of Discussion

• Individual income taxes.
• Characteristics of corporate income taxes.
• Social Security, Medicare, and unemployment taxes.
• Other types of taxes.

Individual Income Taxes

• Self-employed people must self-report and pay taxes quarterly (every 3 months).
• Tax withholding: Employers take tax payments out of employees' pay and send it to the IRS.
  • W-4 Form: Filled out by the employee, covers filing status, additional income, deductions.
  • W-2 Form: Must be sent by the employer to the employee and the IRS.

Current Tax Brackets

• Tax brackets: Brackets with different percentage tax owed for different income levels.
• 7 levels for federal income tax: 10% - 37%.
• Example: If you are a single person who makes around $50,000 a year:
  • The first $9,950$ of your income will be taxed at 10% = $995$
  • $30, 574$ x 12% = $3,669$
  • $9,475$ x 22% = $2,084$
  • In total, you’d pay $6,748$ in taxes.

Filing a Tax Return

• Tax return: Form used to declare income to the government and determine taxable income.
• Taxable income: A person’s total (or gross) income minus deductions.
• Approximately 44% of federal revenue comes from individual income taxes.
• Exemptions were a set amount subtracted from gross income based on dependents, but they were phased out in 2018.
• Deductions are variable amounts subtracted from your gross income (e.g., mortgage interest, medical expenses, business expenses, charity).

Social Security, Medicare, and Unemployment Taxes

• Social Security is a program funded under the Federal Insurance Contributions Act (FICA). Maximum taxable earnings (2023) - $160,200$. It's a regressive tax.
• The majority of FICA taxes fund Social Security (OASDI):
  • Old-Age pension
  • Survivors benefits
  • Disability Insurance (OASDI)
• Medicare taxes fund national health insurance for people aged 65+ and with certain disabilities. Medicare is also funded by FICA.
• Unemployment taxes are collected by both federal & state governments:
  • They provide compensation to laid-off workers looking for work – state-run programs.

Other Types of Taxes

• Excise Taxes: Taxes on specific goods aimed at those who use these items (e.g., gasoline, tires, telephone services).
• Estate Taxes: Paid on the estate of a deceased ($700K$ tax-free).
• Gift Taxes: Paid on money/property given to another ($13K$ tax-free).
• Import Taxes: Paid on imported goods (aka tariffs).
• Sin Taxes: Aimed at discouraging behavior such as the use of cigarettes, liquor, etc.
• Tax incentives can also be used to encourage behavior.

Federal Spending

Topics of Discussion

• Mandatory versus discretionary spending.
• Major entitlement programs.
• Categories of discretionary spending.
• Federal aid impact on state and local government.

Mandatory & Discretionary Spending

• Discretionary spending: Government can make choices. Discretionary programs are subject to the appropriations process every fiscal year (Defense, education, etc.).
• Mandatory spending: Tax revenue mandated by law to be spent on certain programs.
  • Independent of the appropriations process.
  • Funding will only be impacted by further legislation.

Entitlements

• An entitlement program: Social welfare programs that people are “entitled” to if they meet certain eligibility requirements.
• Entitlement programs are the largest category of government spending.

Entitlement Programs

• Social Security: Old age retirement, disability.
• Medicare: Health benefits for all people 65+ regardless of income (also includes people with certain disabilities and diseases).
  • Social Security & Medicare costs are increasing as more Baby Boomers hit eligibility and they’re also living longer.
• Medicaid: Medical care for low-income families, disabled, and elderly in nursing homes. Costs are shared by the federal and state governments.

Discretionary Spending

• Defense Spending:

  • About 54% & largest portion of the federal government’s discretionary spending.
  • Defense spending pays military personnel salaries, buys military equipment, covers operating costs of military bases, etc.

• Other Discretionary Spending:

  • Education
  • Training
  • Environmental cleanup
  • National parks and monuments
  • Scientific research
  • Land management
  • Farm subsidies
  • Foreign aid

• The United States spends more on defense than the next 11 countries combined, with spending at $761 Billion$. Followed by China, with spending at $778 Billion$.

Spending break down for Fiscal year 2019:

• Discretionary 30%
• Net Interest 8%
• Mandatory 62%

Social Security and major health programs account for over half of mandatory spending and totals $\$4.5 trillion$.

State & Local Taxes + Spending

Topics of Discussion

• State budgets.
• State tax expenditures.
• Sources of state tax revenue.
• How local governments use revenues.

State Budgets

• Operating Budgets: Day-to-day expenses (salaries, supplies, and maintenance).
• Capital Budgets: Major capital, or investment, spending.
  • Usually paid with special bond sales and long-term borrowing.
  • Assets such as land & buildings are “real property”.
  • Assets such as furniture & boats are “personal property.”
• Balanced budget: When spending = revenue received.
  • Some states require a balanced operating budget.

Where Are State Taxes Spent?

• Education (2nd largest state expenditure).
  • Higher education: Public universities, plus local public school systems may be included.
• Public Safety:
  • State police & prisons
• Highways and Transportation:
  • Roads, waterways, & airports
• Public Welfare:
  • Public hospitals & clinics
• Arts and Recreation:
  • State parks, museums & historical sites
• Administration:
  • Operating costs of running states and state services

State Tax Revenues

• States collect revenue in different ways.
• Sales taxes: The main revenue for many states, including Texas = 6.25%.
• Other state taxes include state income tax, excise tax, corporate income tax, business tax, and property taxes.

Local Government Spending and Revenues

• The Jobs of Local Government:
  • Public school systems
  • Law enforcement
  • Fire protection
  • Public transportation
  • Public facilities, such as libraries and hospitals
  • Parks and recreational facilities
  • Record keeping (birth/death certificates, wills, etc.)
• Property taxes are the main source of revenue for local government.
• Local governments sometimes collect excise, sales, and income taxes as well.