Roger LeRoy Miller Economics Today Twelfth Edition Chapter 6 Taxes, Transfers, and Public Spending Introduction Educational vouchers allow parents and students to choose among different primary and secondary schools. You can find plenty of voices in support of vouchers, and plenty opposed. What is the proper role of government in providing education? Copyright 2004 Pearson Addison Wesley. All rights reserved. Slide 6-2 Learning Objectives Learning Objectives Understand the key factors influencing the relationship between tax rates governments assess and the tax revenues governments collect. Explain how the taxes governments levy on purchases of goods and services affect market prices and equilibrium quantities. Analyze how Medicare affects the incentives to consume medical services. Explain why increases in government spending on public education have not been associated with improvements in measures of student performance. Understand how the Social Security system works and explain the nature of the problems it poses for today s students. Slide 6-3 Slide 6-4 1
Chapter Outline Did You Know That... Taxation from the Government s Point of View Taxation from the Point of View of Producers and Consumers Public Spending and Transfer Programs Social Security A typical family pays almost 40 percent of its income as taxes to federal state and local governments? These taxes are levied on property, income, retail sales, and inheritances? Slide 6-5 Slide 6-6 Taxation from the Government s Point of View Three sources of government funding Fees, or user charges Taxes Borrowing Taxation from the Government s Point of View The Government Budget Constraint The sum of public spending on goods, services, and transfer payments during a given period cannot exceed tax and fee revenues plus borrowed funds Because borrowed funds must be paid from later taxes, the ability to collect tax revenue defines current spending limits Slide 6-7 Slide 6-8 2
The Tax Base Tax Rates and Tax Revenues Tax Base The value of wealth or transactions subject to taxation Static tax analysis Based on the assumption that changes in the tax rate leave the tax base unaffected Dynamic tax analysis Recognizes that higher tax rates may shrink the tax base Slide 6-9 Slide 6-10 Tax Rates and Tax Revenues Maximizing Sales Tax Revenue If the disincentive effects of higher tax rates are small, static analysis may give a fairly accurate estimate of the change in tax revenues resulting from a tax rate change As tax rates escalate, members of the public have a greater incentive to remove their activities from the tax base. A dynamic analysis would be necessary to determine the overall effect on government revenues. Insert Figure 6-2 I Insert Slide 6-11 Slide 6-12 3
Taxation form the Point of View of Producers and Consumers Effects of Excise Taxes on the Market for Gasoline Excise taxes on gasoline become added costs of production. This shifts the supply curve up by the amount of the unit tax. Consequently, the equilibrium price of gasoline rises and the equilibrium quantity declines. Price per Gallon of Gasoline ($) 2.00 1.90 1.80 1.70 1.60 1.50 1.40 1.30 1.20 1.10 1.00 0.90 0.80 Unit tax = $0.40 D S 2 S 1 Slide 6-13 0 140 160 180 200 220 240 260 Thousands of Gallons of Gasoline per Week Slide 6-14 Who Pays the Tax? The shapes of the supply and demand curves determine how the burden of a tax is split between producers and consumers. In this example, consumers pays 30 cents of the tax and producers absorb the remaining 10 cents. Public Spending and Transfer Programs How taxes are spent Funding public goods Subsidize the consumption of merit goods Finance transfer payment programs such as Medicare Slide 6-15 Slide 6-16 4
Publicly Subsidized Health Care: Medicare Medicare is a program that heavily subsidizes the medical expenses of those over 65. Currently the Medicare tax is 2.9 percent of earnings Retirees are guaranteed that the majority of their doctor s and hospital bills will be paid with public monies Slide 6-17 The Simple Economics of Medicare Each person in America under age 65 pays $1,500 per year in Federal taxes for Medicare 30 percent of Medicare s budget goes to persons in their last year of life The elderly receive benefits worth five to twenty times the payroll taxes plus interest they paid for the program Slide 6-18 The Economic Effects of Medicare Subsidies The Economic Effects of Medicare Subsidies P s When the government pays a per-unit subsidy M for medical care, consumers pay the price Pd and providers receive Ps. S To increase the quantity of medical care, the government pays a subsidy P 0 M The price per unit paid to medical service providers increases The price per unit paid by consumers falls More medical services are consumed P d D Figure 6-5 Q 0 Q m Slide 6-19 Slide 6-20 5
Medicare Incentives at Work Medicare Incentives at Work Problems plaguing Medicare include rising physician incomes, the spread of private for-profit hospitals, and many new tests and procedures due to the rise in the price of medical services. Expenditures are higher than projected because of rising prices and consumption. Total spending on medical services consumes far more income than expected 14 percent of GDP in the United States The highest percent in the world Patients consume many relatively lowvalue services that are very costly to provide Slide 6-21 Slide 6-22 Medicare Spending Today s Challenge: Containing Medicare Spending Current health outlays per older person average about $11,000 per year These expenditures are rising at 4 percent per year By 2020, those 65-and-older will be 16.5 percent of the population versus 13 percent today Reimbursement caps limit total spending on specific procedures Patients are often discharged too soon Drugs are often withheld to cut costs Elderly patients are sicker than they otherwise would be Costs are often higher Slide 6-23 Slide 6-24 6
Today s Challenge: Containing Medicare Spending Recent government policy has been to limit Medicare reimbursement to physicians As a result, a growing number of physicians now refuse to treat any Medicare patients Economic Issues of Public Education State and local governments provide primary, secondary, and postsecondary education at prices well below those that would otherwise prevail in the marketplace Slide 6-25 Slide 6-26 Economic Issues of Public Education The performance of U.S. students compared with those in other countries declines at higher grade levels. Subsidies, which drive a wedge between the cost of providing education and the price paid by the student, may account for this relatively poor performance. Slide 6-27 Social Security Social Security was founded in 1935 to: Prevent retirees and those soon to retire from being destitute as a result of the Great Depression Protect the elderly from similar future disasters Guarantee minimum level of pension benefits to all persons Slide 6-28 7
The Ticking Social Security Time Bomb Private Rates of Return on Social Security Contributions The current Social Security payroll tax rate is 12.9 percent. For Social Security and Medicare to be maintained at current levels, the payroll tax rate will have to rise to 25 percent within the first half of the 21st century. In Slide 6-29 Figure 6-7 Source: Social Security Administration and author s estimates Slide 6-30 Social Security Social Security Social Security s rate of return These were high to begin with because current retirees were paid benefits from growing membership Later retirees collected less because membership growth slowed down For today s college students, negative returns are likely Slide 6-31 Social Security s rate of return High for low-income people Low for blacks Two-income earner families now get a much lower rate of return than oneincome earner families Slide 6-32 8
Social Security Social Security The pre-funding myth Supporters of the current system argue that the system has built up assets The obligations of the system: Benefits the system promises to pay Taxes levied on the public over time Question Given the promised level of benefits, does it matter whether taxes required to pay the benefits are levied before, during, or after the benefits are paid? Answer No. The economic value of taxes now or later must be exactly equivalent. Slide 6-33 Slide 6-34 Social Security How Social Security became the largest taxpayer drain and the most important domestic policy problem In the 1970s the trust fund became very large The World War II generation began to retire and Congress expanded benefits What Will it Take to Salvage Social Security? Raise taxes Either increase the tax rate or the tax base Slide 6-35 Slide 6-36 9
What Will it Take to Salvage Social Security? Reduce benefit payouts Increase the eligibility age Cut benefits to nonworking spouses Introduce means testing What Will it Take to Salvage Social Security? Reform immigration policies Find a way to increase the rate of return on Social Security Slide 6-37 Slide 6-38 Issues and Applications: Education Vouchers Issues and Applications: Education Vouchers Public subsidies to schools permit a gap between the cost of providing education and the benefit to students Vouchers would allow students to choose among different schools Under a voucher system, public funds are given to consumers of educational services, not to producers Slide 6-39 Potential drawbacks of vouchers Lower public school enrollments might result in higher per-pupil costs Some taxpayers object to public funds being transferred to support religiously affiliated private schools Slide 6-40 10
Web Links The following Web links appear in the margin of this chapter in the textbook: http://www.epfnet.org http://www.medicare.gov http://tap.epn.org/ideacentral/economic/ http://www.ssa.gov/history Summary Discussion of Learning Objectives The Relationship between Tax Rates and Tax Revenues How Taxes on Purchases of Goods and Services Affect Market Prices and Quantities The Effect of Medicare on the Incentives to Consume Medical Services Slide 6-41 Slide 6-42 Summary Discussion of Learning Objectives Why Bigger Subsidies for Public Schools Do Not Necessarily Translate into Improved Student Performance How Social Security Works and Why It Poses Problems for Today s Students End of Chapter Chapter 6 Taxes, Transfers, and Public Spending Slide 6-43 Copyright 2004 Pearson Addison Wesley. All rights reserved. 11