Introduction to Government Finance

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Copyright 2002 by Thomson Learning, Inc.

Chapter 10

Introduction toGovernment Finance

Copyright 2002 Thomson Learning, Inc.

Thomson Learning is a trademark used herein under license.

ALL RIGHTS RESERVED. Instructors of classes adopting PUBLIC FINANCE: A CONTEMPORARY APPLICATION OF THEORY

TO POLICY, Seventh Edition by David N. Hyman as an assigned textbook may reproduce material from this publication for classroom

use or in a secure electronic network environment that prevents downloading or reproducing the copyrighted material. Otherwise, no part

of this work covered by the copyright hereon may be reproduced or used in any form or by any meansgraphic, electronic, or mechanical,

including, but not limited to, photocopying, recording, taping, Web distribution, information networks, or information storage and retrieval

systemswithout the written permission of the publisher.

Printed in the United States of America

ISBN 0-03-033652-X


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Federal, State, and LocalRevenue

Sources:

Taxes:

Payroll

Income (Corporate and Personal) Property

Sales and Excise

Estate

Tariffs

Fees

Tuition

Licenses

$2.5 trillion


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Determinants of How Much We

Are Taxed

Political Equilibrium

Market Equilibrium and Its Efficiency

The Distribution of Income


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Taxes

Taxes are compulsory payments togovernment


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Tax Basics Tax Base

The item or the activity that is to be taxed.

Tax Rate Structure

The relationship between the amount that is to be paid in tax and the tax base for a given accounting period.

Marginal Tax Rate

The amount by which the tax increases when the tax base increases.

Average Tax Rate The total amount of tax divided by the total amount of the tax base.

Tax bracket

The range of the tax base in which the marginal rate is constant.


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Descriptors of the Tax Rate

Structure A Progressive Tax has astructure where the

marginal tax rate is increasing and greater than theaverage tax rate.

A Proportional Tax has a structure where themarginal tax rate is constant and equal to theaverage tax rate.

A Regressive Tax has a structure where themarginal tax rate is decreasing and less than theaverage tax rate.


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Figure 10.1 A Proportional Tax Rate Structure

TaxR

ate

(P

ercent)

Tax Base (Dollars per Year)0

tATR = MTR


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Figure 10.2 A Progressive Tax Rate Structure

TaxR

ate

(Percent)

Tax Base (Dollars of Taxable Income per Year)

0

35

25

15

MTR

ATR

4,000 29,000 70,000


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Figure 10.3 An Example of a Regressive TaxStructure

T

axR

ate

(P

ercent)

Annual Labor Earnings per Worker

0

15.30

12.35

2.9

$100,000

MTR

ATR

$76,200


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Average Tax Rates

Tax Brackets

(Taxable Income)

Marginal Tax

Rates (MTR)

Beginning

of Bracket

End of

Bracket

0-$4,000 0 0 0

$4000-$29,000 15 0 11

$29,000-$70,000 25 13 20

Above $70,000 35 20 34*

Average Tax Rates in the US


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How Should the Burden of

Government Be Financed Benefit Principle

Those that benefit the most from a

particular program should pay the most forthat program (Lindahl Tax principle atwork).

Ability-to-Pay Principle Those who have the greatest ability to pay

should be required to pay the most.


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Criteria for Evaluating Alternative

Methods of Government Finance Equity

The distribution of the burden of government finance shouldcoincide with commonly held notions of fairness and ability-to-pay.

Efficiency The system of government finance should raise revenues with only

a minimal loss in efficiency in the private sector.

Administrative ease A government finance system should be relatively easy to

administer in a consistent manner without excessive costs to collect,enforce, and comply with taxes and tax laws.


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Tax Compliance and Evasion

Tax Evasion is the term forillegal ways ofavoiding paying taxes. It is typically the result

of not declaring income or overstatingotherwise legal deductions.

Tax Avoidance is the term for thelegal waysof avoiding paying taxes, typically the result

of avoiding activities that are taxed, delayingthe time in which taxes are owed, or taking anaction designed to lower a tax burden.


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Figure 10.4 Reducing Tax Evasion

Costand

Benefit

Unreported Income per Year (Dollars)

0 D*1

B

MC

MB2

D*

A

MC

MB = MTR

Costand

Benefit


0

MC2C

MC1

CostandBenefit


0

MB = MTR

E

1E

E2

E

E1

MB1 = MTR1

D*

2

D*1

D*2


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Alternatives to Taxation

Debt Finance is the means of financingexpenditures through the issuing of

bonds. Inflationary Finance is the means of

financing expenditures through the

printing of money.


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Figure 10.5 Inflationary Finance

Gunspe

rYear

Butter per Year

0 B2

G2

G1

CI

A

T'B1

T


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More alternatives to Taxation

Donations Money (but more usually time) is voluntarily given to

government. Military service or work in the Peace Corps canbe considered a donation when the compensation is lessthan the market value of the time.

User Charges Payments by users of the government service can be

expected. Examples include tuition, fees paid to enter stateparks, greens fees at publicly owned golf courses.

Earmarked Taxes Taxes can be implemented to fund specific public goods.

Examples include gasoline taxes and tolls designed to fundroad and bridge repair.


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Figure 10.6 User Charges and Efficiency

Char g

e

s

Trash Pickups per Year

0 Q*

C*

C* + S*

MSB = MPB + MEB

MPB

MSC

S*

Z*

Z


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Figure 10.7 User Charges for a CongestibleGovernment-Supplied Service

UserCha

rges

(Centspe

rMil e

)

Vehicles per Mile per Hour

0

E1

20

E2

D2 = MSB2D1 = MSB1MSC

80 100 120 150

E*

N*


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User Charges and Efficiency

Roads and Bridges wear out when too muchweight is concentrated on too few axles.

Tolls motivate the wrong behavior in that theytax per axle rather than on pounds per axle.

Estimates suggest that taxing pounds peraxle and using the revenue to repair roads toa greater strength would pay for itself morethan eight-fold.


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State Lotteries

State Lotteries account for more than3% of state revenues.

Evidence suggests that the lotterysystem is a regressive means ofcreating government revenue.

Introduction to Government Finance

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