Ch. 17 In-Depth Notes on Federal Budget: Taxes and Spending

Outline

• Federal Tax Revenues

• Federal Spending

• Is Government Spending Wasted?

• The National Debt, Interest on the National Debt, and Deficits

• Will the U.S. Government Go Bankrupt?

• Revenues and Spending Undercount the Role of Government in the Economy

• Takeaway

Introduction

• Since the mid-1950s, federal government spending has averaged about 20% of GDP while revenues have averaged about 18% of GDP.

• In 2023, this spending equates to approximately $6 trillion.

• Key questions addressed:

  • Where does the government's money come from?

  • How is this money allocated?

  • How long can spending exceed tax revenues?

Federal Tax Revenues

• In 2023, the federal government collects about $4.7 trillion annually.

• This translates to nearly $14,000 per individual in the U.S.

• Major sources of revenue:

  • Individual Income Tax (50%): $2,345 billion

  • Social Security and Payroll Taxes (34%): $1,586 billion

  • Corporate Income Tax (11%): $501 billion

  • Excise Taxes (1.9%): $91 billion

  • Other Taxes (4%): $187 billion

Definitions

• Marginal Tax Rate: Tax rate applied to the last dollar earned.

• Average Tax Rate: Total tax payment divided by total income.

Individual Income Tax

• Largest source of revenue for the federal government.

• Marginal tax rates for 2023:

  • 10% for incomes <$22,000

  • 12% for incomes from $22,001 to $50,000

  • 37% for incomes >$693,750

Example Calculation of Average Tax Rate

• For an income of $50,000:

  • Tax on first $22,000: 10% → $2,200

  • Tax on next $28,000: 12% → $3,360

  • Total Tax Paid: $5,560

  • Average Tax Rate: rac{5,560}{50,000} imes 100 ext{ = 11.12 ext{ extbackslash%}}

Deductions and Taxable Income

• Standard Deduction (2023): $27,700 for married couples.

• Example: Income of $100,000 taxed as if $72,300.

• Tax deductions available for home mortgage interest, donations, etc.

• Alternative Minimum Tax (AMT): Ensures that higher-income individuals pay at least a minimum amount of tax.

Social Security and Medicare Taxes

• FICA Tax: 6.2% on earnings up to $160,200, paid by workers and employers.

• Medicare Tax: 1.45% paid by both employers and employees.

Corporate Income Tax

• Current corporate tax rate: 21%.

• Many corporations manage to lower their effective tax rates or avoid paying taxes entirely.

Federal Tax System

• The U.S. tax system is progressive; higher income individuals pay a higher percentage in taxes.

• Households in the bottom 20% pay <5% of income in taxes; top 20% approximately 25%.

Federal Spending Breakdown

• Two-thirds of federal budget spent on:

  • Social Security (23%): $1,313 billion

  • Defense (14%): $794.6 billion

  • Medicare (15%): $856 billion

  • Medicaid (9%): $536 billion

  • Interest on Debt (7%): $396 billion

  • Other programs including unemployment and welfare (7%): $407 billion

Is Government Spending Wasted?

• Government spending can be ineffective due to poor incentives and information.

• Instances of waste, for example, in military spending, have historically occurred.

• It is challenging to cut spending on large, well-known programs without eliminating benefits.

The National Debt

• As of 2023, national debt is around $31 trillion; about $25 trillion is publicly held.

• Debt-to-GDP ratio in 2023: approximately 100%.

Interest on National Debt

• In 2023, the U.S. paid about $400 billion in interest on its debt.

• Average interest rate on the debt is a little over 1.6%.

Understanding Deficits

• Deficit: Annual difference between federal spending and revenues.

• When spending exceeds revenue, borrowing occurs to bridge the gap.

The Future

• Concerns about rising debt-to-GDP ratio due to demographic changes and healthcare costs.

• The challenge will be to balance higher Social Security and Medicare payments with tax revenues.

Conclusion

• The federal government plays a significant role in the economy through various means: taxes, expenditures, and implications on fiscal health.

• Essential to consider how changes in demographics and costs could affect future budgets and fiscal policy.

In economics, elasticity measures how the quantity demanded or supplied of a good responds to changes in price, income, or other factors. It indicates the degree of responsiveness. The phrase "elasticity = escape" can conceptually suggest that increased elasticity allows consumers or producers to adjust their behavior more freely in response to market changes, which directs them toward more favorable outcomes or alternatives, i.e., "escaping" unfavorable conditions. For example, when prices rise and demand is elastic, consumers may turn to substitute goods as an escape from higher costs, illustrating the principle of elasticity in action.

The debt-to-GDP ratio measures a country's national debt in relation to its gross domestic product (GDP). As of 2023, the national debt of the U.S. is approximately $31 trillion, with a debt-to-GDP ratio of about 100%. This means that the national debt is roughly equal to the total economic output of the country, indicating a significant level of indebtedness compared to its economic performance.

The marginal tax rate is the tax rate applied to the last dollar earned by an individual. It reflects the percentage of tax applied to the income earned above a certain threshold. For 2023, the marginal tax rates in the U.S. are as follows:

• 10% for incomes less than $22,000

• 12% for incomes from $22,001 to $50,000

• 37% for incomes greater than $693,750

A regressive tax is a tax system wherein the tax rate decreases as the taxable amount increases. This means that lower-income earners pay a higher percentage of their income in taxes compared to higher-income earners. As income rises, individuals pay a smaller fraction of that income in taxes. Common examples of regressive taxes include sales taxes and certain excise taxes, which take a larger portion of income from those with lower earnings, disproportionately impacting them compared to wealthier individuals who are less affected by the same tax rate.