Chapter 13: Government Spending, Taxing, and National Debt

Chapter 13: Government Spending, Taxing, and National Debt

Size of Government

Government expenditures as a percentage of GDP have grown from 23% in 1960 to % in 199

Expenditures of Federal government have risen from 17% to % of the GDP between 1960 and 199

Components of Government Expenditures

Government purchases of goods and services have remained stable at about 20% of the GDP in 1960-97

Transfer payments have grown from 6% to 1% of the GDP over this period

Taxes

Tax revenues as a percentage of the GDP increased from 26% in 1960 to 30% in 1999

Federal tax receipts rose from 18% to 20% of the GDP over this period

Role of Government: Public GoodsRole of Government: Public Goods

Non-rival in consumption: use by one person will not require loss of consumption by another person

Non-exclusive: no one can be excluded from consumption once it is produced

Free-rider problem: everyone uses regardless of tax payments

Role of Government: Externalities

Benefits and costs of one’s consumption and production to third parties

Positive externalities require government subsidies (college education)

Negative externalities require government taxes or regulations (pollution)

Positive Externalities: MSB>MPB

Price

Quantity

MPB

P

P’

Q Q’

A

MSB

B

MPC=MSC

Negative Externalities: MSC>MPC

Price

Quantity

MSC

PP’

Q’ Q

MPCB

A

MSB=MPB

Role of Government: Income Distribution

Progressive taxation and transfer payments to bridge income gap between the rich & poor

Horizontal equity: people with equal income pay equal amount of tax regardless the source of income

Vertical equity: people with higher income pay larger taxes

Incidence of Tax: Inelastic Demand

Quantity

Price

P1

Q1

D

D

S

S

P2S’

S’

Tax is paid by consumer:Forward shifting

Tax

Incidence of Tax: Elastic Demand

Price

Quantity

S’

S’

P

Q1

DD

S

S

Q

P1

TaxTax paid by producer:Backward shifting

Comparative Data

U.S. tax share of the GDP is 31.5%It is the smallest among industrial nationsThe highest share belongs to Denmark, 60%

Composition of Tax Receipts: 1950-2000

Individual income tax share rose from 39.9 to 47.8%Corporate income tax share fell from 26.5 to 10%Social security tax share rose from 11 to 33.8%Excise tax share fell from 19.1 to 3.7%

Effective Federal Income Tax Rates, 1996

Income bracket, $ Tax rate, %

Less than 10,000 8.0

10,000 – 20,000 8.8

20,000 – 30,000 13.3

30,000 – 50,000 17.5

50,000 – 70,000 19.5

70,000 – 100,000 21.1

100,000 – 200,000 22.0

More than 200,000 23.7

Federal Budget Account ($ billions)

Year Receipts Spending Balance

1993 1,154 1,409 -255

1994 1,259 1,462 -201

1995 1,352 1,516 -114

1996 1,453 1,561 -108

1997 1,579 1,601 -22

1998 1,658 1,668 -10

1999 1,743 1,802 +69

Public Debt

Government borrows money from investors through the issuance and sale of government securities or bonds

Investors hold the bonds for a certain time period to make interest income

Government Securities

Non-marketable securities– U.S. Savings Bonds & Notes: redeemable in cash for

the face value after maturity

Marketable securities– Treasury bills (< 1 year; low interest rate)– Treasury notes (1-5 years)– Treasury bonds (> 5 years, high interest rate)

National Debt

Government borrowing to cover budget deficitDebt id owed to – Private investors– Banks and financial institutions– Insurance companies– State & local governments– Foreign governments and private investors

Budget & Debt

Year Budget Surplus

National Debt

Debt Repayment

In $ billions

1998 69 5,479 51

1999* 79 5,615 50

2000* 117 5,712 98

2001* 134 5,781 117

2002* 187 5,818 170

* Estimates

Economic Effects of Federal Debt

Primary burden: opportunity cost of servicing the debt in terms of reduced public investment

Inflationary effect: higher interest rates and prices

Economic Effects of Federal Debt

Income distribution effect: income transfer from government to high income investors

Output effect: higher taxes and opportunity cost of productive investment