GOVERNMENTmrbextermueller.weebly.com/uploads/5/0/0/8/50085613/chapter_20.pdfthat it discouraged...

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Paying for Government The servicesprovided by government cost money. You andalmost everyone else pay taxes to support government spending. What are the effects of government spending? In this chapter youwill learn how government policy affects prices,jobs, and your economic decisions.

To better understand why taxes arenecessary, view the Democracy In

Action Chapter 20 video lesson:

Taxing and Spending

Chapter Overview Visit the United StatesGovernment: Democracy in Action Web siteat gov.glencoe.com and click on Chapter20–Overview to preview chapter information.

GOVERNMENT

★ ★ ★ ★ ★ ★ ★ ★ ★ ★

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http://www.gov.glencoe.com

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Collecting taxes is one way the federal gov-ernment plays a role in the United Stateseconomy. The amount of money thegovernment collects in revenues and the

government’s budget are calculated in figures toolarge for most people to comprehend. In 2003 thenational government took in about $2 trillion inrevenues. That figure represents an average ofnearly $6,300 for each person in the nation. Whatare the sources of all this money? Two majorsources are taxes and borrowing.

Taxes as a Source of RevenueBenjamin Franklin once said, “In thisworld, nothing is certain but death and

taxes.” Taxes are payments by individuals and busi-nesses to support the activities of government. TheConstitution states that Congress

“. . . shall have power to lay and collecttaxes, duties, imposts, and excises, and topay the debts and provide for the commondefense and general welfare of the UnitedStates. . . .” —Article I, Section 8

Today taxes are the chief way the federal govern-ment raises money.

Individual Income Tax The individual in-come tax is the federal government’s biggest sin-gle source of revenue. About 50 cents of everydollar the government collects comes from thissource. In a recent year, the individual incometax produced almost $850 million.

The federal income tax is levied on a per-son’s taxable income, or the total income ofan individual minus certain deductions andpersonal exemptions. People may elect to takedeductions for contributions made to charity,for state and local income taxes paid, for homemortgage interest, and for other expenses.

Raising MoneyS e c t i o n 1S e c t i o n 1

Income Tax ComingCHEYENNE, WYOMING, FEBRUARY 1913

Wyoming has become

the 36th and final

state needed to ratify the

Sixteenth Amendment.

First proposed in 1909, the

constitutional amendment

authorizes Congress to

levy an income tax on

many Americans. Approval

of the amendment con-

cludes a long struggle to

enact a permanent income

tax after an emergency tax on incomes during the

Civil War expired in 1872. Calls for the amendment

began in 1895, when the Supreme Court declared an

income tax law passed the previous year to be un-

constitutional. Congress is expected to act quickly to

pass a new tax bill, which President-elect Woodrow

Wilson has promised to sign.

Americans paying income taxes

Reader’s Guide

Key Termstaxes, taxable income, dependent, withholding, securities, national debt

Find Out■ How does the income tax compare with other

sources of federal revenue in terms of theamount collected?

■ How does the federal government use tax lawsto affect economic decisions?

Understanding ConceptsCivic Participation How are income taxes collected from citizens of the United States?

Democratic and Republican leaders work out tax cuts on Capitol Hill.▲

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Or, people may take a standarddeduction that the governmentcalculates. The government alsopermits personal exemptions that reduce theamount of income that is taxable. Such exemp-tions are based on the number of people who aredependent on the wage earner who pays the in-come tax. A dependent is one who depends pri-marily on another person for such things as food,clothing, and shelter.

The income tax is a progressive tax, one basedon a taxpayer’s ability to pay. The higher a person’staxable income, the higher the tax rate. People withhigher incomes, however, can often take advantageof deductions that lower their taxes. Nevertheless,the wealthiest taxpayers—those with incomes above$50,000—pay about 80 percent of the taxes.

The deadline for filing income tax returns eachyear is April 15. Nearly everyone with taxable incomein the preceding calendar year must file income taxreturns by that date. During the year employerswithhold a certain amount of money from the work-ers’ wages. This withholding pays the anticipatedtaxes ahead of the April 15 filing date. Self-employedpeople—including business owners, tradespeople,and professionals—who do not receive regularsalaries are expected to file estimates of their incomefour times a year and make payments with each esti-mate. In this way those taxpayers avoid having tomake one large annual payment on April 15. At the

same time, the governmentreceives a steady flow of in-come throughout the year.

The Internal Revenue Service (IRS), a bureauof the United States Treasury Department, collectsthese taxes through its regional centers. The IRSreceives and processes about 200 million returnsand supplemental documents each year. IRS staffmembers use computers to quickly check each re-turn. They audit, or check more closely, a smallpercentage of returns each year. The IRS also in-vestigates many suspected criminal violations ofthe tax laws each year.

Corporate Income Tax Corporations, as wellas individuals, must pay income taxes. The federalgovernment taxes all the earned income of a cor-poration beyond its expenses and deductions.Corporate income taxes represent about 10 per-cent of federal government revenues. Nonprofitorganizations such as colleges, labor unions, andchurches are exempt from this tax.

Social Insurance Taxes The federal govern-ment collects huge sums of money each year to payfor Social Security, Medicare, and unemploymentcompensation programs. The taxes collected topay for these major social programs are called social insurance taxes. Employees and employersshare equally in paying the tax for Social Security

556 CHAPTER 20: TAXING AND SPENDING

Taxes in America

Taxes and Public Opinion Do you thinkpublic opinion places any limits on the govern-ment’s ability to tax?

Government Processes Paying taxes often requires filling out complex tax forms. Congress has been asked to review and simplify the taxpaying process.

Citizen Processes By and large, most Americans no longer violently protestgovernment taxes. Here a couple fills outincome tax forms.

▲

▲

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and Medicare. Employers deduct it directly fromeach worker’s paycheck, add an equal amount, andsend the total to the federal government. The un-employment compensation program is a com-bined federal-state operation financed largely by afederal tax on the payrolls of businesses. All thesesocial insurance taxes are often called payroll taxes.

Social insurance taxes are the fastest-growingsource of federal income. In 1950 they amountedto only $4 billion. In fiscal year 2002, these taxesbrought in over $700 billion. Already the second-largest source of federal tax income, social insurance taxes are projected to grow to $810 billion by 2005.

Unlike other taxes, social insurance taxes donot go into the government’s general fund. Instead,they go to Treasury Department special trust ac-counts. Congress then appropriates money fromthese accounts to pay out benefits. These taxes areregressive taxes because people with lower in-comes usually pay a larger portion of their incomefor these taxes than do people with higher incomes.

Excise Taxes Taxes on the manufacture, trans-portation, sale, or consumption of goods and the

performance of services are called excise taxes. TheConstitution permits levying excise taxes, and since1789 Congress has placed taxes on a variety of goods.Some early targets for excise taxes were carriages,snuff, and liquor. Today the government imposes ex-cise taxes on gasoline, oil, cigars, cigarettes, liquor,airline tickets, long-distance telephone service, andmany other things. Some excise taxes are called lux-ury taxes because they are levied on goods such ascigarettes and liquor not considered to be necessities.Excise taxes contribute about $70 billion a year to thefederal government, with highway and airport taxesbringing in the most income.

Customs Duties Taxes levied on goods import-ed into the United States are called customs duties,tariffs, or import duties. The federal governmentimposes customs duties to raise revenue or to helpprotect the nation’s industries, businesses, andagriculture from foreign competition. A high cus-toms duty is called a protective tariff. Many busi-ness, labor, and farm groups support protectivetariffs because they raise the price of foreign goods,making them less competitive compared to Amer-ican goods on the domestic market.

CHAPTER 20: TAXING AND SPENDING 557

Critical Thinking The budget deficit began to increase dramatically in the 1980s. Why do you think the budget deficit began to decline after 2000?

Source: Office of Management and Budget, Budget of the U.S. Government, Fiscal Year 2004,www.whitehouse.gov/omb/budget/fy2004.

* Totals more than 100 percent due to rounding.

Do

llars

(in

bil

lio

ns)

-300

0

-200

-150

-100

-50

50

100

150

200

250

-250

Year20

0019

9019

8019

7019

6019

50

Federal Budget Deficits or Surpluses

State and localFederal

Otherentitlements14%

Non-defensediscretionary19%

Nationaldefense17%

Net intereston debt9%

Medicare and Medicaid 19%

SocialSecurity23%

Federal Spending*Federal Revenues

Othertaxes4%

Excise tax 4%

Corporateincome tax 8%

Socialinsurance tax38% Individual

income tax46%

Federal Taxing and Spending, 2002Federal Taxing and Spending, 2002

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Estate and Gift Taxes An es-tate tax is collected on the assets(property and money) of a personwho dies and a gift tax on gifts ofmoney from a living person. Firstlevied in 1916, the estate tax wasassessed on estates of more than$1,000,000 in 2003. The gift tax ischarged on individual gifts of morethan $11,000 given in one year. Thegift tax prevents people from avoid-ing an estate tax by giving money torelatives and friends before death.Money given to a spouse is exempt.

In the 1990s, the estate tax be-came controversial. Critics arguedthat it discouraged savings and pre-vented small business owners andfarmers from passing their busi-nesses on to their families. In 2001President Bush convinced Congressto cut taxes. The new tax law re-pealed the federal estate tax, phasingit out gradually over several years.

Taxes and the Economy

The tax laws in the UnitedStates are very complex and

can affect actions of citizens. Thefederal government sometimesuses taxes to influence economicdecisions. For example, individualincome tax deductions for home

mortgage interest provide an incentive for homeownership and aid the construction industry.

Groups affected by tax increases have some-times influenced Congress to pass special exemp-tions in order to reduce the taxes they have to pay.The result is that the tax system contains many spe-cial provisions designed to benefit certain groups.

Tax Loopholes Many people believe that pro-visions, or tax exemptions, favoring certaingroups are unfair. These exemptions are often re-ferred to as tax loopholes. Some people can affordto hire attorneys and tax specialists who can findloopholes in the complicated tax laws. People in

Why We Pay Taxes

G overnment makes life better in many ways. If you are an average teen, you probably

drive on area roads and highways, attend public schools, and use the local library. Your safety and property are protected by police and firefighters. You do not expect to be poisoned by the food you eat and the water you drink, or that products you use will harm you. You live free from fear of foreign invasion or guerrilla attack.

No one charges you for these and many other services,benefits, and protections that you enjoy. However, as the old saying goes, “there is no such thing as a free lunch.”Taxes on gasoline maintain highways. Sales, property, and income taxes finance local and state services. Federal income taxes also support many programs and services. In fact, most government activities that enhance the quality of life in the United States are made possible by the taxes we pay.

Investigate Determine the role of government in providingand paying for some facility, program, or service you enjoyin your community.

A C T I V I T YA C T I V I T Yarticipating

I N G O V E R N M E N T articipating

I N G O V E R N M E N T

Using books paid for by taxes

The Constitution gives Congress the authorityto levy customs duties on many imported items.Congress can decide which foreign imports will betaxed and at what rate. Congress, in turn, has giventhe president authority by executive order to raiseor lower the existing tariff rates. In doing so,however, the president must take trade agreementswith other nations into account

Before the income tax, customs duties were amajor source of federal income. As other sourcesof taxes grew, customs duties declined as a share offederal revenue. In a recent year they producedabout $19 billion, or less than 2 cents of every taxdollar collected.

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high-income brackets have used strategies such asdeclaring business losses or investing in tax shel-ters to avoid paying taxes. Other exemptions repre-sent government efforts to encourage an activity. Atax exemption on oil exploration encourages peo-ple to invest their money in businesses searchingfor new energy sources.

Tax Reforms In 1985 President Reagan pro-posed tax changes to eliminate what he termed a“source of confusion and resentment.”The resultingTax Reform Act of 1986 reduced various tax deduc-tions, tax credits, tax shelters, and the number of taxbrackets or rates. In 2003 President Bush signed the Job and Growth Act, which made permanent themassive tax cut passed in 2001. This gave millions of taxpayers a tax reduction and also increased the child tax credit from $600 to $1,000. These cuts were meant to stimulate spending and boostthe economy.

Tax Credits The federal government todayprovides tax credits generally to people in lowerincome brackets. Tax credits allow taxpayers toreduce their income tax liability. Each dollar of taxcredit offsets a dollar of tax liability. The earned-income credit enables many families with lower incomes to receive refunds. Workers who mustpay for the care of their children or other depen-dents receive a tax credit for that expense. Certainelderly and retired people may be entitled to a taxcredit, depending on the amount of their income.

Borrowing for RevenueIn addition to collecting taxes, the federalgovernment borrows money. In 2002, bor-

rowing amounted to about $220 billion, or about 9cents for every dollar the government raised.

Bonds and Other Securities The govern-ment borrows by selling federal securities—finan-cial instruments that include bonds, notes, andtreasury bills. Federal government securities arepopular with investors because they are safe andinterest may not be taxable. The most popularbonds for small investors are savings bonds. In re-turn for lending the government money, investorsearn interest on their bonds. The federal govern-ment pays a huge amount of interest.

The National Debt When the government’sspending is greater than its income, it runs adeficit. Government borrowing to fund annualbudget deficits over time creates the national debt.The size of the national debt affects the federalbudget and the economy.

Sect ion 1 AssessmentSect ion 1 Assessment

Civic Participation Obtain a paycheck stub—yours or a family member’s. Note thecategories and amounts of money deducted forcity and state taxes, FICA, and Social Security.Create a graph that shows the percentage ofthe earned wages deducted in each category.

Checking for Understanding1. Main Idea Use a graphic organizer like the one

below to show the steps in collecting federal income tax.

2. Define taxes, taxable income, dependent, withholding, securities, national debt.

3. Identify progressive tax, IRS, social insurancetaxes, regressive tax, tax loophole.

4. What is the federal government’s biggest singlesource of tax revenue?

Critical Thinking 5. Identifying Alternatives Why does the govern-

ment raise most of its revenues through taxingrather than borrowing?


Student Web Activity Visit the United StatesGovernment: Democracy in Action Web site atgov.glencoe.com and click on Chapter 20–Student Web Activities for an activity about raising money.

GOVERNMENT

April 15Employers Self-employed

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From Washington’s day to the present, thenation has always accounted for its rev-enues and expenditures. Today, the federalbudget enables the government to predict

and control revenue and spending for each year.The federal budget operates in a fiscal year—a 12-month accounting period that extends from Octo-ber 1 of one year to September 30 of the next year.

The budget is an important policy document.It reflects the federal government’s view of the na-tion’s needs and priorities. By showing how muchwill be spent on various national concerns such asdefense and social welfare, it serves as a blueprintfor the federal government’s spending.

George Washington was able to put all the fig-ures for the national government’s expendituresfor one year on one large sheet of paper. Today thefederal budget consists of more than 1,000 pages ofsmall type.

Preparation of the budget involves the effortsof thousands of people and goes on continually.Work on a budget starts a full 19 months before afiscal year begins. Thus, before one year’s budget iscompleted, work on the next year’s budget is al-ready under way.

The executive and legislative branches sharein the preparation of the budget—an example ofchecks and balances at work. Under the presi-dent’s leadership, the executive branch draws upa proposed budget. Congress uses the president’sbudget as a basis for preparing a tax and spend-ing plan to submit back to the president.

Drawing Up the President’s Budget

During much of American history, pres-idents have traditionally played a limited

role in researching and drawing up the budget.Various federal agencies usually sent their bud-get requests directly to the secretary of the trea-sury, who passed them on to Congress.

Preparing the Federal BudgetS e c t i o n 2S e c t i o n 2

Washington Retires PHILADELPHIA, PENNSYLVANIA, SEPTEMBER 1796

George Washington an-

nounced today that he

will not seek a third term

as president. In a statement

released to the press, he also

expressed his concerns for

the nation. Washington

urged government leaders to

avoid unnecessary spending.

“Cherish public credit,” the

president advised, “avoiding

likewise the accumulation of

debt.” He admonished that “toward the payment of

debts there must be revenue,” which will mean taxes.

“No taxes can be devised which are not more or less

inconvenient and unpleasant,” Washington said. He

warned that the alternative would be a national debt

that will unfairly burden future generations of

Americans.

George Washington


Reader’s Guide

Key Termsfiscal year, uncontrollables, entitlement, incrementalism

Find Out■ How do the executive and legislative branches

work together to produce an annual budget forthe federal government?

■ Why is it so difficult for the federal governmentto reduce spending or raise taxes in order tobalance the budget?

Understanding ConceptsPublic Policy What factors prevent the budgetfrom changing very much from year to year?

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The Budget and Accounting Act of 1921changed this procedure in an effort to streamlinethe process. As a result of this law, the president isresponsible for directing the preparation of thebudget and making the major decisions about na-tional budget priorities. The law requires the pres-ident to propose to Congress the budget for theentire federal government each fiscal year. Thisbudget must be delivered within 15 days after Con-gress convenes each January.

The actual day-to-day preparation of the bud-get is the responsibility of the Office of Manage-ment and Budget (OMB). The OMB, along withthe president’s Council of Economic Advisers(CEA), confers with the president on a wide rangeof budgetary matters.

Start of the Process Budget making beginsin early spring for the budget that is to go into ef-fect a year from the following October. Each feder-al agency draws up a list of its own spending plansand sends these requests to the OMB.

The Director of the OMB takes the first set offigures to the president, along with OMB’s analysisof the nation’s economic situation. At this pointthe president, assisted by the secretary of the trea-sury and the CEA, makes key decisions about the impact of the preliminary budget on the administration’s general economic policy andgoals. They discuss such questions as: Will thebudget increase or reduce federal spending? Whichfederal programs will be cut back and which willbe expanded? Will the federal government need to borrow more money? Should taxes be raised or lowered?

Agencies Review Their Budgets TheWhite House returns its decisions on the budget tothe agencies and departments with guidelines tohelp them prepare their final budgets. The Depart-ment of Defense, for example, may be told to cutits budget by $5 billion, and the TransportationDepartment may be told it can increase its budgetby $1 billion.

Over the next few months, the executive de-partments and agencies work on detailed budgetplans fitting the president’s guidelines. During thistime OMB officials and agency heads negotiatecuts and additions to bring each agency’s budget inline with the president’s decisions.

Final Presidential Review Sometime dur-ing the fall, the OMB submits a complete budgetdocument to the president for final review and ap-proval. Some last-minute juggling always takesplace. Agency heads may make last-ditch efforts toconvince the president to overrule an OMB deci-sion and save a particular program. The presidentmay order changes in parts of the budget in re-sponse to pressure from interest groups or politicalparty members.

Finally, the administration rushes the presi-dent’s budget to the printer—often only days orperhaps hours before the January deadline. Thepresident formally sends the budget to Congress


Critical Thinking The Budget and Accounting Act of 1921 requires the president to propose a budget to Congress. What system established in the Constitution guides the budget process?

Source: A Citizen’s Guide to the Federal Budget(Washington, D.C.: Government Printing Office, 1997).

February–December2002

December2002–February2003

March–September2003

October 1,2003

October 1,2003– Sept. 30, 2004

October–November2004

Formulation of the president’sbudget fiscal year 2002

Executive branch agencies develop requests for funds and submit them to the Office of

Management and Budget (OMB). The president reviews requests and makes fiscal

decisions on what goes in the budget.

Budget preparation and transmittalThe budget documents are prepared and

transmitted to Congress.

Congressional action on the budgetCongress reviews the president’s proposed

budget, develops its own budget, and approves spending and revenue bills.

Implementing the budget

The fiscal year begins.

Agency program managers execute the budget provided in law.

Data on actual spending and receipts for the completed fiscal

year become available.

Steps in the Budget ProcessSteps in the Budget Process

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along with an annual budget message. Congressthen takes the next steps in working out the feder-al budget.

Uncontrollables Despite having a key role inthe budget process, the president does not havecomplete freedom in making budgetary decisions.About 70 percent of the federal budget consists ofwhat are called uncontrollables. Uncontrollablesare expenditures required by law or resulting fromprevious budgetary commitments.

A large portion of the uncontrollables arecalled entitlements, or benefits that Congress hasprovided by law to individuals, and which theyhave an established legal right to receive. Entitle-ments include Social Security, pensions for retiredgovernment employees, Medicare, Medicaid, andveterans’ benefits.

Another largely uncontrollable item in thebudget is the interest that must be paid on the national debt. As yearly budgets have forced the

federal government to borrow moreand more money, the interest on thedebt has grown. In fiscal year 2003,interest on the debt amounted to morethan 7 percent of the federal govern-ment’s total expenses.

Congressional Budget Action

Article I, Section 9, of the Con-stitution requires that Con-

gress approve all federal spending.Thus, the president draws up budgetproposals, but only Congress has thepower to raise revenue and pass ap-propriations. No money may be spentand no taxes may be collected untilCongress approves.

Congress may revise the presi-dent’s budget proposals as it sees fit.Conflict between Congress and thepresident over the budget is inevitable.If the opposing party, not the presi-dent’s party, controls either house ofCongress, that house may loudly criti-cize the president’s budget. Even if thepresident’s own party controls Con-

gress, lawmakers may have different ideas than thepresident as to how money should be allocated.Key lawmakers and the president often must nego-tiate over different parts of the budget. Compro-mises are usually necessary on both sides before abudget is passed.

Congressional Budget Act of 1974 Foryears separate subcommittees of the Senate andHouse handled each agency’s requested expendi-tures. This separation made it difficult for Con-gress to keep track of the total annual budget. Toremedy this situation, Congress passed the Con-gressional Budget Act in 1974. This law set upHouse and Senate Budget Committees and theCongressional Budget Office (CBO).

The CBO’s job is to carefully evaluate the over-all federal budget for Congress. The CBO has itsown professional staff of experts. They report toCongress and act as a counterbalance to the OMBin the executive branch.


Balancing the Budget President Clinton and Vice PresidentGore joined with members of Congress to celebrate passageof a balanced-budget bill in 1997. This was the first balanced-budget bill passed in nearly 30 years. Do you think an un-balanced budget is a problem? Why or why not?

Bipartisan Celebration

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Gramm-Rudman-Hollings Act By the mid-1980s the size and growth of the national debtworried economists. In 1985 Congress enacted the Balanced Budget and Emergency Deficit Con-trol Act, known as Gramm-Rudman-Hollings(GRH) after the senators who designed it. This lawwas aimed at forcing the president and Congress to work together to reduce budget deficits.

GRH and later amendments required theOMB and CBO to issue a joint report each year es-timating how much the proposed budget wouldexceed income and how much it should be cut tomeet deficit-reduction targets. The federal budgetdeficit continued to grow because the presidentand Congress could not agree on budgetary prior-ities. The failure to meet deficit-reduction targetsprompted Congress to search for another remedy.

Budgetary Enforcement Act of 1990After lengthy negotiations President George H.W.Bush and the Democratic Congress agreed on theBudgetary Enforcement Act (BEA). The BEA di-vided the budget into three areas: domestic policy,defense, and international affairs. Spending thatexceeded the budgeted limit in any area wouldcome out of the next year’s funding for that area.

A recession in 1990–1991, however, temporar-ily derailed the deficit-cutting plan. When theeconomy improved beginning in 1993, tax receiptsincreased, making the job of reducing the deficiteasier. Some members of Congress called for a bal-anced budget. President Clinton and other mem-bers of Congress, however, were satisfied that theannual deficits had been reduced from more than$300 billion to about $145 billion. In 2000 the na-tional debt equaled more than $5.5 trillion. Thedebt represented 57 percent of the nation’s grossdomestic product.

Key Steps in Congressional BudgetMaking The budget-making process generallyfollows three steps. First, House and Senate BudgetCommittees review the major features of the pres-ident’s budget proposals. On April 15 these com-mittees prepare a concurrent resolution. With thepresident’s proposals as a starting point, this reso-lution sets forth the total federal spending and taxplan for the coming fiscal year.

The next step, called reconciliation, occurs be-tween April 15 and June 15. During reconciliationvarious House and Senate committees reconcile,or fit, the spending and taxing plans set out in the


Leonard Sanders

Making a DifferenceMaking a Difference Taxes pay for many communi-ty services, but a private citizen can also step in to

meet a need. Leonard Sanders, a retired mine worker in the tinytown of Elkville, Illinois, won thestate lottery in 1995. Sandershad plenty of uses for the money.After dividing up his winnings withhis wife and children, however,he decided to direct some of hisextra cash to improving his home-town. Sanders helped restore the90-year-old church where his wifeworshiped as a child. Then hebought and refurbished an emptygrocery store to convert into acommunity center. He purchasedtwo new pool tables, exerciseequipment, furniture, and a

television set for the center.Friends pitched in to build asmall kitchen. The kitchen isstocked with free food and drinkswhich are paid for by a trust.Sanders set up the trust to fundthe operation for future genera-tions. The new community centerprovides a place for Elkville resi-dents to gather for recreation andconversation. Sanders’s addition-al plans for his town include apavilion for the baseball park.

“Money will never change my attitude toward life,” he said.“Elkville is really a nice place witha nice bunch of intelligent people.I’ve known most of them for 20or 30 years, and we have alwaysgotten along.”

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concurrent resolution with existing programs. Thecommittees put the changes made during thisprocess into a reconciliation bill that both theHouse of Representatives and Senate must vote onand approve. The House then passes an appropri-ations bill, officially setting aside money for all expenditures approved through the reconciliationprocess. Congress is supposed to complete this billby June 30, but the bill is often delayed because ofthe complexity of the details that must be approved by both houses.

The final step in the budget process involvesthe procedures spelled out in the GRH Act. Thefiscal year begins on October 1. On October 15 theOMB issues a final report and may make cuts in the budget to fit deficit-reduction targets.

Incremental Budget MakingSome analysts use the term incrementalismto explain the budget-making process. In-

crementalism means that generally the total bud-get changes only a little (an increment) from oneyear to the next. Thus, the best forecaster of thisyear’s budget is last year’s budget, plus a little more.

Incrementalism means that usually federalagencies can assume they will get the same amountof money they received in the previous year. Incre-mentalism also means that most budget debatesfocus on a proposed increment or reduction for anagency. For example, budget battles rarely centeron whether the FBI should continue to exist, butrather on how much of an increase or decrease theFBI should get for that particular year.

A budget may reflect a president’s specific policy.President Bush’s proposed budget for 2002 includeddecreased funding for transportation, agriculture,and environmental protection. The president andhis aides portray the cuts as an attack on pork bar-rel projects—ones that supply funds for local improvements designed to foster good relations between legislators and the people they represent.


Public Policy Imagine that you are a part of apresidential committee set up to decide thespending priorities for next year’s governmentbudget. Your job is to list the four top areasthat you think should have the greatest shareof the budget. Prepare a supporting argumentfor the four areas you have chosen.


below to show how the budget process is affected if Congress and the president are fromdifferent political parties.

2. Define fiscal year, uncontrollables, entitlement, incrementalism.

3. Identify Office of Management and Budget, Congressional Budget Office.

4. Identify four entitlements that are a part of thefederal budget.

Critical Thinking5. Expressing Problems Clearly Why does the fed-

eral government find it difficult to raise taxes orreduce spending to balance the budget?


CAUSE EFFECT

Taxing Problem Like any other citizen,U.S. presidents can choose to keep their taxrecords private. Still, since the early 1970s,most presidents have made at least part oftheir returns public. In 2003, for example,President and Mrs. Bush reported a taxableincome of $727,083; they paid $227,490 infederal taxes. Vice President Dick Cheney andwife Lynne had an even better year, with ataxable income of $813,226; they paid$258,779 in federal taxes.

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toto

SHOULD THE FEDERALINCOME TAX BE REPLACED?

TAXPAYER COMPLAINTS

American taxpayers provide the Internal Rev-enue Service (IRS) with information about theirearnings each year. By filing their income tax re-turns, taxpayers save the government millions ofhours of work. Many people complain, however,that the system is too complicated. Others arguethat tax rates are unfair because people earningmore money pay a higher percentage of theirincome. Some people report that the IRS isunresponsive to taxpayer questions and that itaggressively targets taxpayers who complain.

A POLITICAL ISSUE

Some politicians have suggested that thewhole tax structure should be replaced. SteveForbes, a former presidential candidate, suggested

replacing the incometax with a flat tax. Another alternativewould be a nationalsales tax. A sales tax,unlike the income tax,would not require an army of IRS agents to enforce the tax and check taxpayer returns. Tax loopholes that have developed with the current income tax would all be eliminated if the income tax were replaced.

Supporters of the income tax, however, pointout that it is a progressive tax, collecting a largerpercentage from more wealthy taxpayers than frompoorer ones. The income tax can be used to redis-tribute wealth by giving tax credits to the poorestcitizens. Making the system more efficient, notabandoning it, is the answer, they argue.

Assume that you are a taxpayer testifying at acongressional committee hearing, weighing the ad-vantages and disadvantages of the income tax.

KEY ISSUES✔ How much time and effort does it take for theaverage person to complete and file his or her in-come tax returns?✔ Is the IRS responsive to taxpayer questions?✔ What are the advantages and disadvantages ofthis system of collections?

✔ What other form of taxation would provide fairer taxation with less effort?

Debate Prepare a statement in support of oragainst the income tax. Allow time for two peopleon each side of the argument to present their statements to the class.

Vote Make your decision. Then have the class votefor or against replacing the current income tax withanother tax.

Debating the IssueDebating the Issue

WOULD YOU SUPPORT OR REPLACE THE FEDERAL INCOME TAX?

For decades the income tax has provided the bulk of federal government revenue.The system operated by the IRS has been reliable in generating consistent federal tax

revenues for many years. Despite this record, many people believe that the income tax should be replaced or undergo a major overhaul.

IRS logo

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Federal government policy has a significantbearing on the economy. The Federal Re-serve Board’s decisions affect the moneysupply. Officials in both the executive and

the legislative branches make difficult decisions totry to promote a healthy economy.

Where the Money GoesThe federal government was spendingabout $4.6 billion a year when Franklin D.

Roosevelt became president in 1933. Today, thatamount would pay for less than one day of the fed-eral government’s expenditures. The governmentcurrently spends more than $2 trillion a year.

How can a person imagine such a largeamount of money? Perhaps it is more meaningfulto break the total amount down into its four majorcomponents. In addition to interest on the nationaldebt, the main spending items are direct benefitpayments to individuals, national defense, anddiscretionary spending.

Direct Benefit Payments Spending forSocial Security and social-welfare and health-careprograms has become a big part of the federalbudget. Almost half of every dollar spent goes forsuch items. In a recent budget, the federal gov-ernment allocated about $960 billion for directbenefit payments of one kind or another.

Uncontrollable expenditures account for alarge portion of this budget item. The biggest en-titlement program is Social Security. In 2002Social Security benefits totaled over $450 billion.

National Defense Spending for nationaldefense was one of the biggest items in the bud-get beginning with World War II. When RonaldReagan became president in 1981, he made abigger Defense Department budget a major ob-jective of his administration. He felt that theworld situation called for further increases inspending for military equipment and training.

Managing the EconomyS e c t i o n 3S e c t i o n 3

Rate Cuts Seek StabilityNEW YORK, NOVEMBER 6, 2001

The Federal Reserve

slashed interest rates

by one-half point today

in a bold move to prevent

the economy from slip-

ping into a recession. It

was the tenth rate cut this

year and the third since

terrorist attacks rocked

the financial district last month. The central bank has

acted aggressively to shore up the economy, dropping

the federal funds rate from 6.5 percent to just 2 percent

in less than a year. The cost of borrowing money is

now at its lowest level since 1961.

Consumer confidence sank following a four-day

shutdown of the New York Stock Exchange triggered

by the terrorist attacks that destroyed the World Trade

Center, just blocks away. It was the longest shutdown

since the Great Depression.

Cartoon depicting

Chairman Greenspan


Reader’s Guide

Key Termsfiscal policy, monetary policy, gross national product (GNP), discount rate, reserve requirement,open-market operations

Find Out■ What is the difference between fiscal policy

and monetary policy?■ What are the four major categories of federal

government spending?

Understanding ConceptsPublic Policy Why must the Fed operate free ofpressures from Congress or the president?

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When changes in the SovietUnion and Eastern Europe signaledan end to the Cold War, PresidentGeorge H.W. Bush announced ad-justments in United States defense.He vowed to eliminate some nuclearweapons and to end the around-the-clock alert posture of strategicbombers, and he asked the Sovietsto do the same. The Clinton admin-istration reduced the share of thebudget that goes to defense. In 1996defense spending represented about17 percent of total outlays, downfrom 22 percent in 1992.

By the 2000 election, many peo-ple felt that defense spending hadbeen reduced too much. PresidentGeorge W. Bush fulfilled a campaignpromise to increase spending for themilitary. In 2001 the defense budgetincreased by over $11 billion. Themilitary response following the Sep-tember 11, 2001, terrorist attacksagainst the United States demandedmore increases. By 2003 the defense budget hadincreased by $81 billion from its 2000 figure.

Discretionary Spending The federal govern-ment spends a sizable portion of tax revenues onthe environment, transportation, criminal justice,and other areas. Much of this discretionary spend-ing is in the form of grants to states and localities.State and local governments use federal grants forroad repair, public housing, police training, schoollunch programs, flood insurance, and so on.

States and communities have come to rely onthis intergovernmental revenue for an increasingshare of their total revenue. Between 1980 and1989, however, federal grants to state and localgovernments declined. More recent federal bud-gets have increased federal aid to states while shift-ing federal grants away from infrastructureinvestments and toward public-welfare programs.

Fiscal and Monetary PolicyBeginning with the Great Depression ofthe 1930s, the federal government has

taken an increasing role in managing the nation’s

economy. Arguments continue over just howlarge a part the government should play. Debatesarise because, in the modified free-enterprise sys-tem, control over the economy is divided betweengovernment and the private sector—individualsand businesses. Yet most Americans expect thefederal government to play a significant role inmoderating the economy’s ups and downs, whilepromoting steady economic growth.

The government uses two primary devices toinfluence the direction of the economy: (l) fiscalpolicy and (2) monetary policy. Fiscal policy in-volves using government spending and taxation toinfluence the economy. Monetary policy involvescontrolling the supply of money and credit to in-fluence the economy. This control is exercisedthrough the Federal Reserve System.

Fiscal Policy The federal budget is a majortool of fiscal policy because it shapes how muchmoney the government will spend and how muchit will collect through taxes and borrowing. Thepresident and Congress can use the budget topump money into the economy to stimulate it, orto take money out of the economy to slow it down.


Critical Thinking Many countries in the world spend more money than they take in as revenue. Which governments represented in the graph received more revenue than they spent?

Source: CIA, The World Fact Book 2003 (Washington, D.C.: 2003).

BrazilCountry

United States

United Kingdom

Mexico

Kuwait

Japan

Italy

Canada

Dollars (in billions)

$540

$718$441

$18$11

$161$179

$92$101

$2,052$1,946

$140$136

$517$504

$565

Revenue Expenditures

Government Revenue and Expenditures

COMPARING GovernmentsCOMPARING Governments

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To stimulate the economy, the government mayspend more money than it takes in. Through in-creased spending the government aims to put morepeople back to work and increase economic activity.

Another way that the government can stimulatethe economy is through reducing taxes. Lower taxesgive consumers and investors more purchasingpower.

When the government increases spending orreduces taxes, it is likely to run a deficit because itmust spend money that it does not have. Since the1930s the United States has had deficit, or unbal-anced, federal budgets most of the time. One rea-son for these deficits is that for many years theseunbalanced budgets were thought to benefit theeconomy. In addition, this policy was very popularpolitically because it allowed the government tospend heavily on social programs that manyAmericans were demanding.

This policy of deficit spending led to increas-ingly large budget deficits and a growing nationaldebt. During the 1970s and early 1980s, econo-mists began to worry about the effects this wouldhave on the nation’s future.

Demands for cutting the deficit and even bal-ancing the budget grew. Many economists, how-ever, argued that a balanced budget would meanthe federal government could not use fiscal policyto shape the economy. Some said that the deficit asa percentage of the gross national product (GNP)was more important than the deficit alone. TheGNP is the sum of all goods and services pro-duced in the nation in a year. They pointed outthat the deficit still represented only 5 to 6 percentof the GNP.

Other economists disagreed. They pointed tothe rapid growth of the deficit and of the nationaldebt itself. When Congress promised to balancethe budget in 1981, the gross federal debt was $930 billion. In 2003 it reached $3,939 billion ($3.9 trillion). Interest payments on the debt nearlyequaled half of that spent for defense.

Monetary Policy The United States economyis a market economy. Americans exchange goodsand services through a vast system of money andcredit. The Constitution gives the national gov-ernment authority to “coin money [and] regulate

the value thereof.” Today, the fed-eral government tries to regulatethe economy through its mone-tary policy.

Monetary policy involves con-trolling the supply of money andthe cost of borrowing money—credit—according to the needs ofthe economy. The governmentcontrols the money supply throughthe Federal Reserve System.

The Federal Reserve System

The Federal Reserve Sys-tem, known as the Fed,

is the central banking system ofthe United States. When people orcorporations need money, theymay borrow from a bank. Whenbanks need money, they may go tothe Fed. Thus, in reality, the Fed-eral Reserve System is a banker’sbank.


Critical Thinking The public debt increased by almost $4 trillion from 1940 to 2003. What factors or policies contribute to a budget deficit?

Source: Bureau of the Public Debt, 2003.

*Public debt does not include money the government owes itself.

Debt (in millions)

Year

1940

1950

1960

1970

1980

1990

2003

$42,772

$219,023

$236,840

$283,198

$711,932

$2,411,831

$3,939,850

The Public Debt,* 1940–2003The Public Debt,* 1940–2003

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Organization of the Fed The United States isdivided into 12 Federal Reserve Districts. Each dis-trict has 1 main Federal Reserve Bank. In addition,most Federal Reserve Banks have branch bankswithin their districts.

About 5,700 of the approximately 13,600banks in the United States are members of the Federal Reserve System. These include all the large banks in the country. These member bankscontrol the largest share of total bank deposits inthe United States.

Board of Governors A 7-member Board ofGovernors in Washington, D.C., supervises the en-tire Federal Reserve System. The president selectsthese members whose appointments must be rati-fied, or approved, by the Senate. The president se-lects one of the board members to chair the Boardof Governors for a 4-year term.

Once appointed, board members and thechairperson are independent of the president.Even Congress exercises little control or influence

over the board, since the board does not dependon Congress for an annual appropriation for oper-ating expenses. This allows the Board of Governorsto make economic decisions independent of polit-ical pressure.

Making Monetary Policy The Board ofGovernors has two major responsibilities in form-ing monetary policy. First, it supervises the opera-tions of the Federal Reserve Banks in the 12districts across the country. Second, and most im-portant, it determines the general money andcredit policies of the United States.

The Fed uses three main tools to control the fi-nancial activities of the nation’s banks and,through them, the nation’s monetary policy. First,the Fed can raise or lower the discount rate. Thediscount rate is the rate the Fed charges memberbanks for loans. Low discount rates encouragebanks to borrow money from the Fed to makeloans to their customers. High discount rates meanbanks will borrow less money from the Fed.


Seattle

Helena

Salt LakeCity

El PasoDallas

HoustonSan Antonio New Orleans

Miami

Jacksonville

Birmingham

Atlanta

CharlotteLouisvilleSt. Louis

Nashville

Kansas CityDenver

Omaha

MinneapolisDetroit

Boston

New York CityPhiladelphiaBaltimore

RichmondWashington, D.C.

PittsburghCincinnati

ClevelandBuffalo

Chicago

MemphisLittleRock

OklahomaCity

Portland

San Francisco

Los Angeles

1

2

34

5

6

7

8

9

10

11

12

12

12

Critical Thinking The United States is divided into 12 Federal Reserve Districts. Federal Reserve Districts are privately owned but publicly controlled. What do low discount rates from the Federal Reserve encourage banks to do?

Source: Board of Governors of the Federal Reserve System, The Federal Reserve System: Purposes & Functions(Washington, D.C., 1994).

Boundaries of Federal Reserve Districts

Boundaries of Federal Reserve Branch Territories

Board of Governors of the Federal Reserve System

Federal Reserve Bank Cities

Federal Reserve Branch Cities

Federal Reserve DistrictsFederal Reserve Districts

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Second, the Fed may raise or lower the reserverequirement for member banks. Member banksmust keep a certain percentage of their money inFederal Reserve Banks as a reserve against their de-posits. If the Fed raises the reserve requirement,banks must leave more money with the Fed. Thus,

they have less money to lend. When the Fed lowersthe reserve requirement, member banks have moremoney to lend.

Third, the Fed can put money into the econo-my by buying government bonds and other secu-rities on the open market. These open-marketoperations stimulate and help expand the econo-

my. The Fed may also sell government securities.As investors spend their money on these

securities, money is taken out of theeconomy, causing it to slow down.

Conflicting Policies Inrecent years the Fed has becomean independent policy-makinginstitution. While the presidentand Congress largely controltaxing and spending, they havelittle control over the Fed, whichdetermines monetary policy.Thus, the Fed’s policy may aid or hinder presidential and con-gressional economic programs.

Conflicting economic policies sometimes arise,causing presidents or Congress to complain that theFed is interfering with their economic programs.

Because of such conflicts, some people wouldlike to limit the Fed’s role and make it less inde-pendent. Others maintain that the nation needs aninstitution removed from political pressures towatch over monetary policy.

Controller of the Money Supply

Federal Reserve Chairman Alan Greenspanand the Board of Governors try to preserve econom-ic growth by regulating the money supply. Shouldthe federal government have more or less con-trol over the nation’s economy? Explain.

The seal of theFederal Reserve

Public Policy Research several back issues ofThe Wall Street Journal or selections from theReaders’ Guide to Periodical Literature to ana-lyze Federal Reserve Board decisions that affectthe economy. Create a poster of headline captions showing the Fed’s actions.


below to compare recent federal grants withthose in the 1980s.

2. Define fiscal policy, monetary policy, gross na-tional product (GNP), discount rate, reserve re-quirement, open-market operations.

3. Identify the Federal Reserve System, Board ofGovernors.

4. Analyze why the federal government adoptedpolicies that created a huge debt.

Critical Thinking5. Identifying Alternatives What methods could

the federal government use to stimulate theeconomy during a time when people were opposed to deficit spending?



Federal Grants1980s Recently

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571

Analyzing News Media

Every citizen needs to be aware of currentissues and events in order to make gooddecisions when exercising citizenship

rights. To stay informed, people use a varietyof news sources, including print media,broadcast media, and electronic media.

Learning the Skill

To get an accurate profile of currentevents, you must learn to think criticallyabout the news. The steps below will help youthink critically.• First, think about the source of the news story.

Reports that reveal sources are more reliablethan those that do not. If you know thesources, you can evaluate them.

• Many news stories analyze and interpretevents. Such analyses may be more detailedthan other reports, but they also reflect a re-porter’s biases. Look for biases as you read orlisten to news stories.

• Ask yourself whether the news is even-handedand thorough. Is it reported on the scene orsecondhand? Does it represent both sides ofthe issue? How many sources are used? Themore sources cited for a fact, the more reliableit usually is.

Practicing the Skill

Follow the steps below to analyze two types ofprint media.1. Find two articles, one in a current newspaper

and the other in a newsmagazine, on the issues of government taxing or spending.

2. What points were the articles trying to make?Were the articles successful? Can the facts beverified?

3. Did either of the articles reflect a bias towardone viewpoint or the other? List any unsupported statements.

4. Do the articles seem to represent both sidesfairly?

5. How many sources can you identify in the articles? List them.

Application ActivityApplication ActivityThink of an issue in your community or

in the nation on which public opinion is di-vided. Read newspaper features and editori-als and monitor television reports about theissue. Can you identify any biases? Whichreports more fairly represent the issue?Which reports are the most reliable?

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Reviewing Key TermsInsert the terms below into the following paragraphto describe how the federal government regulatesthe economy. Do not use a term more than once.

withholding securitiesnational debt taxestaxable income incrementalismfiscal policy GNPmonetary policy fiscal yearentitlements uncontrollables

The federal government collects more than $1 trillion in (1) each year. Through (2) wage earnerspay taxes on their (3) during the year. The govern-ment’s (4) begins on October 1. Because of (5) suchas (6) in the budget, government spending often exceeds revenue, which enlarges the (7). Someeconomists are not alarmed because deficits areonly about 5 percent of the (8). Others would like to see changes in (9) to control spending or raise

taxes. By its (10) the Fed may stimulate economicgrowth to relieve some of these concerns.

Recalling Facts1. What is the deadline for filing individual

income tax returns?2. Identify three institutions that are exempt from

the federal income tax.3. What are three responsibilities of the Internal

Revenue Service?4. What are four types of taxes that the federal

government collects?5. What executive agency is charged with prepar-

ing the federal budget?6. Why are federal securities such as bonds

popular with investors?7. What is the goal of the Gramm-Rudman-

Hollings Act?8. What factors make it difficult for Congress to

cut spending?9. Identify state and local uses of intergovern-

mental revenues.

Understanding Concepts1. Public Policy Why has the United States been

unable to balance the national budget most ofthe time beginning in the 1930s?

2. Public Policy What kinds of banks are mem-bers of the Federal Reserve System?

Assessment and ActivitiesChapter 20Chapter 20

Self-Check Quiz Visit the United States Government:Democracy in Action Web site at gov.glencoe.com andclick on Chapter 20–Self-Check Quizzes to preparefor the chapter test.

GOVERNMENT

• Individual income tax• Corporate income tax• Social insurance taxes• Excise taxes• Customs duties• Estate and gift taxes• Borrowing (by selling bonds,

notes, and certificates)

RevenuePresident directs budget preparation and sets budget priorities; day-to-day budget preparation is carried out by the Office of Management andBudget (OMB) along with the Council of Economic Advisers (CEA)

Federal Budget• Social Security • Social welfare programs• Healthcare benefits • National defense • Discretionary spending

(grants to state and local government for road repair, public housing, police training, school lunch programs, etc.)

Expenditures

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Critical Thinking1. Making Generalizations Why

would business groupssupport protective tariffs?

2. Analyzing Information Whymust the Federal ReserveBoard of Governors operatefree of pressure from thepresident or Congress?

3. Identifying Alternatives Usea graphic organizer like theone below to show twomeasures the federal gov-ernment could take if thenational debt seemed tobe growing too fast.

Analyzing Primary SourcesOne of the first major taxes the new constitutionallybased government placed on the fledgling Americanrepublic was a 1794 tax on whiskey. Western farm-ers saw this tax as a direct attack on their busi-ness, and in Pennsylvania in particular, theyrevolted against this tax, often with arms. GeorgeWashington, the nation’s first president, quelled therebellion with troops. Read the excerpt from Wash-ington’s proclamation about the Whiskey Rebellionand then answer the questions that follow.

“. . . [C]ombinations to defeat the execution of the laws lay-ing duties upon spirits distilled within the United States andupon stills have from the time of the commencement of thoselaws existed in some of the western parts of Pennsylvania. . . .[T]he said combinations, proceeding in a manner subversiveequally of the just authority of government and of the rightsof individuals, have hitherto effected their dangerous andcriminal purpose by the influence of certain irregularmeetings whose proceedings have tended to encourage anduphold the spirit of opposition by misrepresentations ofthe laws calculated to render them odious . . . employingfor these unwarrantable purposes the agency of armedbanditti disguised in such manner as for the most part to escape discovery.”

Interpreting Political Cartoons Activity

1. What type of resistance did opponents of thewhiskey tax employ to express their disapprovalof the government’s actions?

2. Why do you think taxes are not protested so violently today?

Participating in Local GovernmentReview the various kinds oftaxes that are sources of rev-enue for local governments.Working in groups of three, complete the following tasks:

1. Identify three needs that your community has.2. Estimate the amount of taxes that would need

to be raised to meet these needs.3. Determine whether any current tax rate may

be increased to meet one or more of theseneeds.

4. Decide on any additional fair tax to raisemoney to benefit the needs that you haveidentified.

5. Discuss whether people will be in favor of additional taxes to meet these needs. Summarize your findings in an informationalbrochure or flyer.


Chapter 20Chapter 20

1. What is this man doing?2. How does he seem to feel about this?3. Do you think this man’s feelings are representative of the

general feeling of taxpayers? Explain.RapidlyGrowingDebt

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