layout: true background-image: url(figs/tcb-logo.png) background-position: bottom right background-attachment: fixed; background-origin: content-box; background-size: 10% --- class: title-slide .row[ .col-7[ .title[ # Principles of Macroeconomics ] .subtitle[Taxes and Government Spending] .author[ ### Dennis A.V. Dittrich ] .affiliation[ ] ] .col-5[ ] ] --- class: practice-slide # 1. .col-8[ How large are government expenditures as a share of GDP? ] --- .row[ ![](fig11/unnamed-chunk-1-1.png)<!-- --> Government's expenditures are a substantial share of GDP ] --- .row[.col-6[ ![](fig11/unnamed-chunk-2-1.png)<!-- --> ] .col-6[ ![](fig11/unnamed-chunk-3-1.png)<!-- --> ]] --- # Sources of Government Revenue - USA ![](img11/f3601.jpg) --- # The Individual Income Tax .row[.col-6[ ![](img11/f3602.jpg) ] .col-6[ **Marginal tax rate**: the tax rate paid on an extra dollar of income. * If the marginal tax rate is 10%, tax owed on an additional $100 will be $$0.10 \times \$100 = \$ 10.$$ * important as it affects incentives. **Average tax rate**: total tax payment divided by total income. * Marginal tax rates are set by government (the average tax rate is calculated after tax owed is known). * Not all income is taxed; there may be Exemptions and Deductions. ]] --- class: practice-slide # 2. .col-8[ In 1989, US Senator Bob Packwood asked Congress's Joint Committee on Taxation how much extra revenue the government would raise if it just started taxing 100% of all income over $200,000 per year. The Joint Committee crunched some numbers and reported an answer: $204 billion per year. a. What is wrong with this answer? b. Under Packwood’s proposal, what would the marginal tax rate be at $250,000 per year? At $500,000 per year? ] ??? a. If people knew that every dollar over $200,000 would be taken by the federal government, very few people would choose to earn more than $200,000 per year.Thus, the income simply wouldn’t be there to generate $204 billion per year in tax revenue. Perhaps the government could raise a few billion per year, from people who kept working without noticing that the government took all of their money, but under this law, most people would stop working once their family earned $200,000 per year. b. The marginal rate at both income levels would be the same: 100%. --- class: practice-slide # 3. .col-8[ Suppose the government enacts a new payroll tax of 10% of worker wages, _paid_ fully by employers. What will happen to the typical firm's demand for labor? Will that tax increase or decrease the employer's willingness to hire workers? ] --- # Tax Revenues .col-7[ * Taxes on Capital Gains, Interest, and Dividends * Social Security and National Insurance taxes * Chile (1981): privatization of social security -- employers no longer had to pay payroll taxes for their employees. Result? Wages rose. * Corporate Income Tax paid by... * Shareholders and bondholders * Workers (in the form of lower wages) * Consumers (in the form of higher prices) * Conservatives favor lower tax rates ] --- class: practice-slide # 4. .col-8[ Tax burden: Who (income percentile) pays what (share of tax revenues)? ] --- # Tax Burden: Who Pays What? -- USA .row[.col-6[ ![](img11/tax1-2018.jpg) A **progressive tax** code implies that tax rates are higher on people with higher incomes. Most countries have a progressive tax code. Until 2018, the USA had a progressive tax code, too. Not anymore. ] .col-6[ ![](img11/tax2-2018.jpg) Source: https://itep.org/who-pays-taxes-in-america-in-2018/ ] ] --- ## Total Tax Rate in the USA 1950 and 2018 .row[ .col-6[ ![](img11/tax1.jpeg) ] .col-6[ ![](img11/tax2.jpeg) ] ] --- .row[.col-7[ <img src="img11/taxburden2018.png" width="100%" /> ] .col-5[ ### In 2018, for the first time in history, US billionaires paid a lower tax rate than the working class [Ingraham, Christopher, Oct. 8, 2019. Washington Post.](https://www.washingtonpost.com/business/2019/10/08/first-time-history-us-billionaires-paid-lower-tax-rate-than-working-class-last-year/) ]] --- class: practice-slide # 5. .col-8[ To help to understand the distributional consequences of the tax cuts advocated by many conservative politicians, answer the following: 1. What income groups have the largest marginal propensity to consume: how or low income? 2. If your goal were to minimize the deficit cost of a stimulus, who should receive the tax cuts? ] --- ## Where does the tax money go? ![](img11/f3604.jpg) --- class: practice-slide # 6. .col-8[ Social Security is primarily a pay-as-you-go program, which means that the government pays retirees their promised benefits by taxing today’s workers. Imagine that Social Security moved to a fully funded program in which today’s workers (or the government on their behalf) invested in assets, such as stocks and bonds, to pay for their own retirement. a. Discuss some of the costs and benefits of a fully funded program. b. Discuss some of the difficulties of transitioning to the new system. (Hint: If today’s workers pay for their own future retirement, who will pay today’s retirees?) ] ??? a. If today’s workers were required to save for their retirement, the U.S. savings rate would probably increase. We know from Chapter 7 on the Solow model that an increase in the savings rate will increase the capital stock and thus the U.S. standard of living—this is probably the biggest potential benefit of a fully funded system. Investing in stocks, however, is risky. Investing in bonds is safer but the returns will not be as high. The latter two problems could probably be handled by careful investment rules. The more difficult problem is the transition problem b. Once a pay-as-you-go program begins, it is difficult to unwind. At present, today’s workers are paying for the benefits of today’s retirees. If today’s workers must pay for their own future retirement, who will pay for today’s retirees? Must today’s workers pay twice: once for today’s retirees and once for their own retirement? That doesn’t seem fair. We could borrow to fund the benefits of today’s retirees, but remember that the big gain to a fully funded system is the increase in the savings rate. If the government must borrow trillions of dollars to fund the retirement of today’s retirees, the net U.S. savings rate may --- ## Where does the tax money go? .row[.col-7[ Social Security, Pensions * Often run on a _pay as you go_ basis: Current contributions pay for benefits of current retirees. * Some people advocate raising the full retirement age. * Net benefits are declining over time. * Higher taxes on today's workers funds larger benefits for yesterday's workers. Defense * The U.S. spends more on its military than any other country. Unemployment Insurance and Welfare Everything else ] .col-5[ ![](img11/tab3602.jpg) ]] --- class: practice-slide # 7. .col-9[ What causes budget deficits? Are budget deficits necessarily a bad thing? ] ??? More government expenditures than tax revenues. Deficits can be good when an economy is operating below its potential because they increase aggregate demand and total output. Deficits can be bad in the long run if they lead to lower investment because lower investment will lead to lower growth. --- # Deficits and Surpluses .row[ .col-7[ ![](img11/f3606.jpg) ] .col-5[ A **deficit** is a shortfall of revenues under payments A **surplus** is an excess of revenues over payments In **the short run**, if the economy is below potential, deficits are good because deficits increase expenditures moving output closer to potential **Long-run** surpluses are good because they provide saving for investment ]] --- ## Arbitrariness in Defining Surpluses and Deficits .col-7[ Whether a nation has a deficit or surplus depends on what is included as revenues and expenditures * There are many ways to measure expenditures and receipts, so there are many ways to measure deficits and surpluses Deficit and surplus figures are summary measures of the financial health of the economy * To understand the summary, you must understand the methods that were used to calculate it ] --- ## Budget Balance: Surplus and Deficits .row[.col-6[ ![](img11/budget.png) ] .col-6[ ![](img11/budget-map.png) ] ] --- class: practice-slide # 8. .col-9[ How are deficits financed? ] ??? The government finances its deficits by selling bonds to private individuals and the Fed Bonds are promises to pay back the money in the future. The Central Bank can print an unlimited amount of money to buy bonds, but printing too much money can cause inflation. --- # Financing the Deficit .col-7[ * The government finances its deficits by selling bonds to private individuals and the Fed * Bonds are promises to pay back the money in the future * The Central Bank can print an unlimited amount of money to buy bonds, but printing too much money can cause inflation ] --- class: practice-slide # 9. .col-8[ What is the difference between a _structural deficit_ and a _passive deficit_? ] ??? Structural deficit is the part of the budget deficit that would exist even if the economy were at its potential income Passive deficit is the part of the deficit that exists because the economy is operating below its potential level of output There is disagreement about what percentage of a deficit is structural and what percentage is passive Actual deficit = structural deficit + passive deficit Passive deficit = tax rate x (potential – actual output) Structural deficit = actual deficit – passive deficit --- # Structural and Passive Deficits .row[.col-7[ Many government revenues and expenditures depend on the level of income in the economy **Structural deficit** is the part of the budget deficit that would exist even if the economy were at its potential income **Passive deficit** is the part of the deficit that exists because the economy is operating below its potential level of output There is disagreement about what percentage of a deficit is structural and what percentage is passive ] .col-5[ Actual deficit = structural deficit + passive deficit Passive deficit = tax rate x (potential -- actual output) Structural deficit = actual deficit -- passive deficit ]] ??? class: practice-slide # 10. .col-8[ Two economists are debating whether the natural rate of unemployment is 4% or 6%. Mr. A believes it’s 4%; Ms. B believes it’s 6%. One says the structural deficit is $40 billion; the other it’s $20 billion. Which one says which? Why? ] --- class: practice-slide # 11. .col-8[ What is the difference between real deficit and nominal deficit? ] ??? Real deficit = Nominal deficit - Inflation x Total debt --- ## Nominal and Real Surpluses and Deficits .row[.col-7[ A **nominal deficit** is the difference between expenditures and receipts A **real deficit** is the nominal deficit adjusted for inflation Inflation reduces the value of the debt Lowering the real deficit by inflation can be costly * Persistent inflation becomes built into expectations and causes higher interest rates ] .col-5[ Real deficit = Nominal deficit -- (Inflation x Total debt) ]] --- class: practice-slide # 12. .col-8[ What is the difference between _federal deficit_ and _federal debt_? ] --- # Debt and Assets .col-7[ **Debt** is accumulated deficits minus accumulated surpluses * Debt is a stock, defined at a point in time **Deficits and surpluses** are flow concepts, defined for a period of time * If a country has more surpluses than deficits, the accumulated surpluses minus accumulated deficits are a part of its assets * Governments must sell new bonds to pay for a deficit and refinance previously issued bonds as they come due ] --- class: practice-slide # 13. .col-8[ What are potential problems with excessive federal debt? How can the debt be repaid? ] --- .row[.col-6[ ![](fig11/unnamed-chunk-5-1.png)<!-- --> ] .col-6[ ![](img11/grossdebt-map.png) ![](img11/grossdebt.png) ]] --- class: practice-slide # 14. .col-8[ Should there be a balanced budget law? What problems might such a law create? ] ??? Would eliminate automatic stabilizers, therefore act as a destabilizer. --- class: practice-slide # 15. .col-8[ What are three ways in which individual debt differs from government debt? ] ??? The government lives forever; people don’t. People have to pay back, governments don’t. The government can print money; people can’t. Government owes much of its debt itself-to its own citizens. --- .col-7[ ### Individual vs Government Debt The government lives forever; people don't The government can print money to pay its debt; people can't Government owes much of its debt to itself (to its own citizens) ### Debt Management Debt, as a summary measure of a nation's financial situation, needs to be judged in relation to a nation's assets When the government runs a deficit, it might be spending on projects that increase its assets If the assets are valued at more than their costs, then the deficit is making society better off ] --- # Ownership of the US Debt .row[.col-7[ <img src="img11/3401.jpg" width="100%" /> ] .col-5[ **Internal debt** is government debt owed to other governmental agencies or to its own citizens **External debt** is government debt owed to individuals in foreign countries ]] --- class: practice-slide # 16. .col-8[ Why do economist distinguish between internal and external debt? ] ??? Paying interest on internal debt involves a redistribution of income of the country’s citizens. On average people in the country are neither richer nor poorer. External debt is more like individual debt, paying interest involves a net reduction in domestic income. Domestic taxpayers will be poorer, foreigners richer. --- ## Demographic Challenge for Public Finance .col-7[ **Life expectancy** increases and **birth rates** decline The share of the **working population** shrinks If technological and productivity progress is slower than the change in the dependency ratio GDP/capita will decline Challenge not only for publicly financed pensions and social security Private pensions, health insurance, etc. are also affected ] --- class: practice-slide # 17. .col-8[ Describe a change in the tax system that might increase private saving. If this policy were implemented, how would it affect the market for loanable funds? ]