Fiscal Policy, Taxes, and Spending

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Fiscal Policy, Taxes, and Spending

• Outline
• How large is the public sector?
• Federal expenditures and revenues by category.
• State local government expenditures and
  revenues by category.
• Principles of taxation.
• Personal tax rates under the 1993 Tax Reform Act.
• Why a sales tax is regressive

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Federal, State Local Government Spendingas a
Percent of GDP
www.economagic.com
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Source Economic Report of the President
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Source Economic Report of the President
Other includes spending for libraries,
hospitals, health, employment security, water
transport and terminals, police and fire, solid
waste management, parking, corrections, parks and
recreation, housing, and other items.
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Major Categories of Federal Spending, 2000
www.census.gov
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Principles of Taxation
If Madonna or Bill Gates paid the same amount in
taxes as an accountant or government
employee, that would be vertically inequitable

• Horizontal equity Tax code should be written so
  that those in the same economic circumstances pay
  the same amount in taxes.
• Vertical equity Tax code should be written so
  that those in different economic circumstances
  should pay an unequal amount in taxes.
• Benefits received principle Those who derive
  more benefits from government programs should pay
  more taxes.

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Definitions

• Taxable income Gross income - income exempt from
  taxes. Example For single filers who use the
  1040EZ

• Average tax rate (ATR) Tax payments as a percent
  of taxable income.
• Marginal tax rate (MTR) The tax rate applied to
  the last dollar of taxable income.

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Definitions, continued

• Progressive tax The proportion of taxable income
  taken in taxes increases as taxable income
  increases.
• Regressive tax The proportion of taxable income
  taken in taxes decreases as taxable income
  increases.
• Proportional tax The proportion of taxable
  income taken in taxes remains constant as
  taxable income increases.

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The tax code is a tool for income redistribution
Affluent
Needy
By making the tax structure progressive,
governments can make the after-tax distribution
of income more equitable (or even).
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Federal personal Income Tax rates Under the 1993
Tax Reform Act (Married couple filing jointly)
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Average and Marginal Tax Rates under the Tax
Reform Act of 1993 (for a couple with 2 children)
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Why a sales tax is regressive
Assume a 7.13 percent excise tax on groceries,
gasoline, cigarettes, and liquor
Family (1)Income (2)Spending for items subject to excise tax (3) (2)/(1) (4) Excise Tax Paid (5)(4)/(1)ATR
Greens 27,000 16,200 .60 1,188 4.4
Jones 64,000 25,600 .40 1,871 2.9
Lemons 270,000 40,500 .15 2,961 1.0
Moral of the story Low income families tend to
spend a greater proportion of their income on
items subject to excise taxes. Hence excise taxes
tend to be regressive.