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permission, copyright © 1999 by The McGraw-Hill Companies, Inc.
place discrimination as a result of
their disability.
“A person is
Examining the Newsclip
judged too dis-
1. Analyzing Information How has the govern-
abled to qualify
ment attempted to reduce the effect of discrim-
for work but
ination against disabled workers in our society?
not disabled
2. Drawing Conclusions In your opinion, have
enough to be
these efforts been successful? Why or why not?
covered by the

210
Employment Trends and Issues
Main Idea Key Terms
Important employment issues include union decline, giveback, two-tier wage system, glass ceiling, compa-
unequal pay, and the minimum wage. rable worth, set-aside contract, part-time worker, min-
imum wage, current dollars, real or constant dollars,
Reading Strategy base year
Graphic Organizer As you read the section, complete
Objectives
a graphic organizer similar to the one below to
explain why comparable worth is difficult to apply. After studying this section, you will be able to:
1. Explain why union membership has declined.
2. Describe reasons for the discrepancy in pay
Re




Re
as




as



between men and women.
on




on



Comparable worth
Applying Economic Concepts
Minimum Wage Have you ever worked at a job and
on




on
as




as




earned exactly $5.15 an hour? Read to find out more
Re




Re




about the minimum wage.




I
mportant issues abound in today™s labor market.
Cover Stor y The two-tier wage structure discussed in the
cover story, along with other issues, have an
enormous impact on morale”and consequently, pro-
on
Two-Tier Pay More Comm ductivity”in the economy.
tic
takeovers and energe
Between corporate them-
ers than ever are finding
Decline of Union Influence
cost-cutting, more work
selves on the same run-
A significant trend in today™s economy is the
way as the pilots of
American Airlines and decline in both union membership and influ-
its subsidiary, Reno Air: ence. As Figure 8.7 shows, 35.5 percent of nonagri-
They™re working the cultural workers were members of unions in 1945.
same jobs for the same This number fell to 21.9 percent by 1980, and then
employer but taking dropped to under 13.9 percent by 1999.
Pilots™ pay may show
home vastly different striking differences.
paychecks. a
ge system is the result of Reasons for Decline
Whether a “two-tier” wa with
merger of two companies
formal union contract, a Several reasons account for the decline in
sing use of tempo-
y practices, or an increa
different pa union membership and influence. The first is that
verita-
ge differentials create a
rary workers . . . such wa ...
rkplace, critics contend. many employers made a determined effort to
ble caste system in the wo a valuable tool for keep unions out of their businesses. Some
ers consider such wages
Employ
. (but) the concept activists even hired consultants to map out legal
yrolls under control . .
keeping pa ething of a fad in
ges, which became som strategies to fight unions. Other employers made
of tiered wa unpopular among
has become decidedly workers part of the management team, adding
the 1980s,
employees to the board of directors or setting up
employees.
es, February 28, 1999 profit-sharing plans to reward employees.
”The Los Angeles Tim


CHAPTER 8: EMPLOYMENT, LABOR, AND WAGES 211
ECONOMICS
Figure 8.7
AT A GLANCE
AT A GLANCE

Union Membership
40%

35%
as Percent of Employment




30%
Union Membership




25%

20%

15%

10%

5%

0%
30

35

40

45

50

55

60

65




75

80

85

90

95

00
70
19

19

19

19

19

19

19

19




19

19

19

19

19

20
19



Years
Source: Bureau of Labor Statistics, 1999


Using Graphs Union membership grew rapidly after 1933 and peaked at 35.5 percent in 1945. How
would you describe the trend of union membership during the 1980s? During the 1990s?




Renegotiating Union Wages
A second reason for union decline is that new
additions to the labor force”especially women Because unions have generally kept their wages
and teenagers”traditionally had little loyalty to above those of their nonunion counterparts, union
organized labor. Because many of these workers wages have been under pressure.
represent second incomes to families, they have a One way employers have been able to reduce
tendency to accept lower wages. union wages is by asking for givebacks from union
The third and perhaps most important reason workers. A giveback is a wage, fringe benefit, or work
for the decline is that unions are the victims of rule given up when a labor contract is renegotiated.
their own success. When unions raise their wages Some companies have been able to get rid of labor
substantially above the wages paid to nonunion contracts by claiming bankruptcy. If a company can
workers, some union-made products become show that wages and fringe benefits contributed sig-
more expensive and sales are lost to lower-cost nificantly to its problems, federal bankruptcy courts
foreign and nonunion producers. This forces usually allow a company to terminate its union con-
unionized companies to cut back on production, tract and establish lower wage scales.
which causes layoffs and unions to lose some of Another way to reduce union salary scales is
their members. with a two-tier wage system”a system that keeps

212 UNIT 3 MACROECONOMICS: INSTITUTIONS
high wages for current workers, but has a much Advisors released an extensive report called
lower wage for newly hired workers. As noted in Explaining Trends in the Gender Wage Gap that sheds
the cover story, this practice is becoming wide- light on the situation.
spread in industry, and often has union approval.
Human Capital Differences
In Ohio, for example, locals of the International
Union of Electronic Workers have multitiered According to the report, about one-third of the
contracts with General Motors, Ford, and gap was due to differences in the skills and experi-
Chrysler. One contract even pays starting workers ence that women bring to the labor market. For
55 percent of standard pay, and requires 17 years example, women tend to drop out of the labor
before a worker can reach the top scale. force to raise families, whereas men do not. The
report found that working women had lower levels
of education than their male counterparts. If these
Lower Pay for Women two factors”experience and education”were the
same for both men and women, one-third of the
Overall, women face a considerable gap
wage gap would disappear.
between their income and the income
received by men. As Figure 8.8 shows, female
Gender and Occupation
income has been only a fraction of male income
The study also concluded that slightly less than
over a 40-year period”with a 26-percentage-point
one-third of the wage gap was due to the uneven
gap for the most recent year.
distribution of men and women among various
This gap has been the subject of much study. In
occupations. To illustrate, Figure 8.9 shows that
1998, the President™s Council of Economic


ECONOMICS
Figure 8.8
AT A GLANCE
AT A GLANCE

Median Female Income as a Percentage of Male Income
80
Female/Male Earnings Ratio




70
60
50
40
30
20
10
0
55



60



65



70



75



80



85



90



95



00
19



19



19



19



19



19



19



19



19



20




Years
Source: Bureau of Labor Statistics, 1999


Using Graphs Over the years, the income earned by females has been only a fraction of that
earned by males. When did median female income first reach 70 percent of male median
income?


CHAPTER 8: EMPLOYMENT, LABOR, AND WAGES 213
ECONOMICS
Figure 8.9
AT A GLANCE
AT A GLANCE

Distribution of Male and Female Jobs by Occupation
Construction Trades and Crafts
Mechanics and Repairers
Construction Laborers
Engineers
Motor Vehicle Operators
Health Diagnosing Occupations
Lawyers and Judges
Mathematical and Computer Scientists
Machine Operators, Assemblers
Sales Supervisors and Proprietors
Teachers, College and University
Food Service Workers
Computer Operators
Sales, Retail and Personal Services
Teachers, except College and University
Health Service Workers
Private Household Service Workers
Secretaries, Stenographers, and Typists
100% 80% 60% 40% 20% 0 20% 40% 60% 80% 100%
Females Males
Source: Employment and Earnings, 1999


Using Graphs One of the reasons for the pay differential between the sexes is that men and
women are not evenly distributed among occupations. If men tend to cluster in higher-paid
occupations, and if women tend to cluster in lower-paid occupations, the average pay for men and
women will differ. In what occupations do women make up between 60 and 80 percent of
the workforce?



more men enter construction and engineering could not be explained. Accordingly, many ana-
trades than do women. Likewise, women enter the lysts attribute this to discrimination that women
private household service and office-worker occu- face in the labor market. In fact, women and
pations in relatively greater numbers than men. minorities often feel that their difficulties in get-
As long as construction and engineering wages are ting raises and promotions are like encountering a
higher than private household and office worker glass ceiling, an invisible barrier that obstructs
wages, men, on average, will earn more than women. their advancement up the corporate ladder.

Discrimination Legal Remedies
The study also found that more than one- Two federal laws are designed to fight wage and
third”or about 11 percentage points”of the gap salary discrimination. The first is the Equal Pay

214 UNIT 3 MACROECONOMICS: INSTITUTIONS
Act of 1963 which prohibits wage and salary dis- These issues, along with a lack of federal legisla-
crimination for jobs that require equivalent skills tion and the reluctance of the courts to interfere
and responsibilities. This act applies only to men with the market, have limited the popularity of com-
and women who work at the same job in the same parable worth in the United States. Comparable
business establishment. worth is widely used in Europe and Canada,
The second law is the Civil Rights Act of 1964. however.
Title VII of this act prohibits discrimination in all
areas of employment on the basis of gender, race,
color, religion, and national origin. The law
Set-Aside Contracts
applies to employers with 15 or more workers,
Another corrective measure is the government
although it specifically excludes religious associa-
set-aside contract, a guaranteed contract reserved
tions and their educational institutions.
exclusively for a targeted group. The federal gov-
The Civil Rights Act of 1964 also set up the
ernment, for example, requires that a certain per-
Equal Employment Opportunity Commission
centage of defense contracts be reserved exclusively
(EEOC). The EEOC investigates charges of dis-
for minority-owned businesses.
crimination, issues guidelines and regulations, con-
Another example is a 1988 California law requir-
ducts hearings, and collects statistics. If a pattern of
ing that 5 percent of the state™s bond contracts be
discrimination is discovered, the government can
set aside exclusively for women lawyers, bankers,
bring suit against a company.
and other females who help place the bonds with
investors. Such laws ensure that states do not give
all of their business to males in a male-dominated
Comparable Worth profession.
One measure used to close the income gap Most set-aside programs are beginning to add
between men and women is comparable worth, “graduation” clauses that “promote” minority-
the principle stating that people should receive owned businesses out of the program once they
equal pay for work that is different from, but just as reach a certain size or have received set-aside con-
demanding as, other types of work. tracts for a certain number of years. After all, the
In the state of Washington, for example, a fed- intent of the program is to give these firms a boost,
eral judge ruled that work performed by social not a permanent subsidy.
service workers”most of whom were female”was
just as demanding as some traditionally male
occupations. The judge ordered the state to raise
wages and give workers several years™ back pay. In
Illinois, job evaluators determined that the work
done by highway workers was roughly equivalent The End of Work?
to that done by nurses. Some analysts in the past contended that the
Comparable-worth decisions are not easy to make computer age would result in less work for
because so many factors, such as occupational haz- humans. What™s happening, however, is that
ards, educational requirements, and degree of phys- more people are working more hours. The
ical difficulty must be taken into consideration. average number of hours worked per week has
Some people”including most economists”believe increased from 40 hours in 1973 to 50 hours
that fair and unbiased comparisons of occupations today. Why is this happening? One explanation
is that computers don™t replace human thought
are almost impossible to make. This group also
and endeavor, they extend it. By allowing peo-
argues that comparable worth is not needed as long
ple to communicate easily at any time from any
as people are free to obtain training and to enter the
place, computers increase the amount of time
profession of their choice. Others argue that compa-
people work.
rable worth is necessary to remove gender discrimi-
nation in the marketplace.

CHAPTER 8: EMPLOYMENT, LABOR, AND WAGES 215
Critics of Part-Time Employment
The arguments against part-time jobs are that
Big Macroeconomics The magazine The Economist wages are too low, and the hours too few, for work-
uses the price of a McDonald™s Big Mac sandwich, ers to earn a decent living. In addition, no benefits
converted to U.S. dollars, as an indicator of the com-
are offered. Some part-time workers feel that they are
parative value of major world currencies. It operates
being abused by the system and forced to work at
on the notion that a dollar should buy the same
inconvenient times. Others feel that the system
amount in all countries. In July 1999, the average
denies full-time employment to a large number of
American price (including tax) of the Big Mac was
capable workers.
$2.42. A Big Mac in Switzerland costs the most”
Unions are especially opposed to part-time
$4.02. The price of the sandwich in the People™s
workers. The 1997 strike at United Parcel Service
Republic of China costs the least”$1.16. In other
words, the Swiss franc is the most overvalued cur- (UPS) was partially over this issue. According to
rency and the Chinese yuan is the most undervalued. the union, lower paid, part-time workers were rou-
tinely scheduled into four-hour shifts even though
they wanted full-time employment.
Part-Time Workers
One of the more remarkable trends in the
The Minimum Wage
labor market has been the rise in part-time
employment. Part-time workers”or those workers The minimum wage”the lowest wage that can
who regularly work fewer than 35 hours per week” be paid by law to most workers”was first set in
account for one out of five jobs in the U.S. economy. 1939 at $.25 per hour. As Panel A in Figure 8.10
In some states, like North Carolina, part-time labor shows, the minimum wage increased over time until
accounts for nearly 25 percent of the workforce. it reached $5.15 in 1997.

Reasons for Growth
Debate Over the Minimum Wage
Part of the reason for the part-time job growth is
The minimum wage has always been controver-
the evolving nature of the economy. When retail
sial. Its original intent was to prevent the outright
stores stay open for more hours, they often need
exploitation of workers and to provide some degree
workers to fill in at odd times”and the checks
of equity and security to those who lacked the skills
received by part-time workers are often welcome
needed to earn a decent income.
additions to the family income. Also, the odd hours
Supporters of the minimum wage argue that
give some workers the opportunity to do other
these objectives”equity and security”are consistent
things, such as take college classes, that would nor-
with the economic goals of the United States.
mally interfere with the standard 40-hour workweek.
Besides, they say, the wage is not very high in the
The use of part-time workers also gives employ-
first place. Opponents of the minimum wage
ers more flexibility to schedule workers for peak
object to it on the grounds of economic freedom”
periods, such as during lunch or supper at fast-food
also a U.S. economic goal. This group also believes
restaurants. Businesses also like the lower cost of
that the wage discriminates against young people
part-time workers because they receive few of the
and is one of the reasons that many teenagers can-
health, retirement, and other benefits received by
not find jobs.
full-time workers. When the savings from these
Some parts of the country have even instituted
fringe benefits are combined with lower part-time
their own equivalent of a minimum wage. The city
hourly salaries, the sums can be substantial. Figures
of Los Angeles, for example, has a “living wage” that
for 1999 from the Bureau of Labor Statistics show
is substantially higher than the federal minimum
that part-time employee wages and fringe benefits
wage. Any company doing business with the city is
averaged slightly over $10 per hour, as compared to
required to pay its workers at least that amount.
more than $20 for full-time workers.

216 UNIT 3 MACROECONOMICS: INSTITUTIONS
ECONOMICS
Figure 8.10
AT A GLANCE
AT A GLANCE

The Minimum Wage
A The Minimum Wage in Current Dollars
$7.00
Current Dollars per Hour




6.00
5.00
4.00
3.00
2.00
1.00
0
39




49




59




69




79




89




99
19




19




19




19




19




19




19
B The Minimum Wage Adjusted for Inflation
Constant 1992 Dollars per Hour




$6.00
5.00
4.00
3.00
2.00
1.00
0
39




49




59




69




79




89




99
19




19




19




19




19




19




19
C The Minimum Wage as a Percent of the Average Manufacturing Wage
60
% of Average Wage




50
40
30
20
10
0
39




49




59




69




79




89




99
19




19




19




19




19




19




19




Sources: Statistical Abstract of the United States, Economic Report of the President, various issues


Using Graphs The minimum wage is expressed in current dollars in Panel A, adjusted for inflation
in Panel B, and as a percent of the average wage for workers in manufacturing in Panel C. Even
though the minimum wage was $3.35 an hour during most of the 1980s, the minimum wage
adjusted for inflation decreased. Explain why this occurred.


CHAPTER 8: EMPLOYMENT, LABOR, AND WAGES 217
Measured in Current Dollars went to $5.15. However, the minimum wage
remained the same in 1998 and 1999 while prices
Panel A in Figure 8.10 shows the minimum wage
went up, so the wage actually purchased a little less
in current dollars, or in dollars that are not
as time went by. As long as the minimum wage
adjusted for inflation. The minimum wage is
remains unchanged, and as long as inflation contin-
recorded exactly as it was from 1939 to 1999.
ues, its purchasing power will continue to decline.
When viewed in this manner, it seems as if the
minimum wage increased dramatically over time.
The figure, however, does not take into account
Compared to Manufacturing Wages
inflation, which erodes the purchasing power of the
In Panel C, the minimum wage is shown as a per-
minimum wage.
cent of the average manufacturing wage. In 1968,
for example, the minimum wage was $1.60 and the
Adjusted for Inflation average manufacturing wage was $3.01. If we divide
To compensate for inflation, economists like to the two, the minimum wage works out to be 53.2
use real or constant dollars”dollars that are percent of the manufacturing wage for that year.
adjusted in a way that removes the distortion of When measured in this manner, 1968 was the
inflation. This involves the use of a base year”a peak year. After 1968, the ratio slowly declined to
year that serves as a comparison for all other years. approximately 37 percent by 1999. As long as the
Although the computations are complex, the minimum wage stays at $5.15, and as long as man-
results are not. Panel B, using a base year of 1992, ufacturing wages continue to go up, this ratio will
shows that the minimum wage had relatively more continue to decline.
purchasing power in 1968 than in any other year. The minimum wage will certainly be raised
As long as the base year serves as a common again. What is not certain is when this will happen.
denominator for comparison purposes, the results When the minimum wage becomes unacceptably
would be the same regardless of the base year used. low to voters and their elected officials, Congress
Panel B also shows that the purchasing power of will increase it. Some people even want to link the
the minimum wage goes up whenever it increases minimum wage to inflation, so that the wage will
faster than inflation, as it did in 1997 when the wage automatically rise when prices rise.




Checking for Understanding 6. Explain why it is necessary to consider infla-
1. Main Idea Using your notes from the graphic tion when examining the minimum wage.
organizer activity on page 211, write a defini-
Applying Economic Concepts
tion of comparable worth in your own words.
7. Minimum Wage A number of arguments exist
2. Key Terms Define giveback, two-tier wage both in favor of and against having a mini-
system, glass ceiling, comparable worth, set- mum wage. With which side do you agree?
aside contract, part-time worker, minimum Why?
wage, current dollars, real or constant dollars,
base year.
3. List three reasons for the decline of unions.
8. Drawing Conclusions In your opinion, do
4. Describe three reasons for the income gap
cultural stereotypes influence the income
between men and women.
gap between men and women?
5. Describe the current trends in part-time
employment. Practice and assess key social studies skills with
the Glencoe Skillbuilder Interactive Workbook,
Level 2.


218 UNIT 3 MACROECONOMICS: INSTITUTIONS
Section 1 Section 3

The Labor Movement (pages 193“198) Labor and Wages (pages 205“209)
• •
Craft or trade unions, and industrial unions were Four noncompeting labor grades are unskilled labor,
established by the end of the Civil War. semiskilled labor, skilled labor, and professional
labor.
• Unfavorable public attitudes existed toward labor:

The Sherman Antitrust Act was used against labor Workers usually find it diffi-
and even the Clayton Act was ignored by the cult to move to a higher
courts. income group because of the
cost of education and training,
• Attitudes shifted in favor of labor during the
the lack of opportunities for
Great Depression with the passage of the Norris-
education and training, and
LaGuardia Act, the Wagner Act, and the Fair Labor
lack of individual initiative.
Standards Act.
• The traditional theory of wage
• Public opinion shifted against labor again
determination uses the market
after World War II. The Taft-Hartley Act in 1947
forces of supply and demand to explain wage rates;
limited union activity and allowed states to pass
the theory of negotiated wages argues that the relative
right-to-work laws.
strength of a union is a factor; signaling theory argues
• The union movement was dominated by the AFL that certificates and diplomas are signals of ability.
and the CIO, which merged in 1955 to form the
• Wages also differ because of labor mobility, the cost
AFL-CIO.
of living, and attractiveness of work locations.


Section 4
Section 2
Employment Trends and Issues
Resolving Union and Management
(pages 211“218)
Differences (pages 200“203)
• Union membership is declining because of anti-
• The closed shop (now illegal), requires that employ- union activities by firms, labor force additions that
ers hire only union members selected by the union. have little loyalty to labor, and unions that have
The union shop requires that an employee join the priced themselves out of some markets.
union shortly after being hired. The modified union
• Corrective measures include anti-discrimination laws,
shop gives the employee the option to join the
the principle of comparable worth, and set-aside
union after being hired. The agency shop requires
contracts.
that workers pay dues to the union, but does not

require the workers to join, even though the union Part-time jobs are increasing, providing flexible, low
represents all workers. cost options to employers.
• •
When collective bargaining fails, several other The minimum wage has lost much of its purchasing
methods are available to settle labor disputes, power because of inflation. It is also falling behind
including mediation, arbitration, fact-finding, the when measured as a percent of the average manufac-
use of injunctions, and seizure. turing wage.



CHAPTER 8: EMPLOYMENT, LABOR, AND WAGES 219
4. Outline the progress of unions since the end of
World War II.

Section 2 (pages 200“203)
Self-Check Quiz Visit the Economics: Principles
5. Describe the four types of union arrangements.
and Practices Web site at epp.glencoe.com and
click on Chapter 8”Self-Check Quizzes to prepare
6. Explain five approaches to resolving a deadlock
for the chapter test.
that may occur between a union and a company™s
management.

Reviewing Key Terms Section 3 (pages 205“209)
Classify each of the terms below as pro-union, antiunion, or 7. Explain the differences between the four
neither. major categories of noncompeting labor.
1. boycott 8. Explain why it is so difficult for workers to
2. closed shop move from one category of labor to another.
3. company union
9. Compare the three theories of wage
4. compulsory arbitration
determination.
5. fact-finding
10. Discuss the reasons for regional wage differences.
6. giveback
7. grievance procedure
Section 4 (pages 211“218)
8. lockout
9. modified union shop
11. Explain why unions have lost members, as well as
10. seizure
influence, in recent years.
11. injunction
12. Describe two corrective measures being taken to
12. picket
close the income gap between men and women
13. right-to-work law
workers.
14. agency shop
15. strike 13. Explain the popularity of part-time employment.
16. two-tier wage system 14. Identify three ways to evaluate the minimum
17. arbitration wage.
18. mediation

Thinking Critically
Reviewing the Facts
1. Making Generalizations Unions generally argue
Section 1 (pages 193“198)
that the best interests of workers can be served when
1. Describe current union influence in terms of employees are members of a union. Do you agree or
membership and workers represented by unions. disagree with this statement? Defend your answer.
2. Compare the two types of unions in the post- 2. Analyzing Information Some people believe that
Civil War period. in today™s economy, the theory of negotiated wages
3. Describe the advances made by unions during the is more useful than the traditional theory of wage
Great Depression. determination. Explain why you agree or disagree.



220 UNIT 3 MACROECONOMICS: INSTITUTIONS
Create webs like the ones below to help you Thinking Like an Economist
organize your answer.
Economists think of transactions in a market econ-
omy as being voluntary, with participants evaluating
Advantages
their decisions incrementally, meaning that they evalu-
Traditional wages
ate the costs and benefits of every action as they go
Disadvantages
along. Use this way of thinking to explain the rise of
part-time employment.
Advantages
Negotiated wages
Disadvantages
Technology Skill
Using the Internet Visit the U.S. Department of
Applying Economic Concepts Labor Web site. Search and find the summary of cur-
rent employment. Then rewrite the paragraph that
1. Civilian Labor Force As you go to and from follows. Employment (rose/fell/remained unchanged).
school, take note of the various occupations around The unemployment rate stands at (?) percent in the
you. List at least 10 occupations, then classify them latest month. Average weekly hours (declined/
according to the four major categories of labor. increased/remained unchanged), and average hourly
earnings (fell/rose/were unchanged) at the end of the
2. Minimum Wage Poll at least 10 people of various
month.
ages, asking for their opinions on the following state-
ment: There should be no minimum wage. Compile
the responses and present your findings to the class.


Math Practice Evaluating Primary and Secondary Sources
Economists define wages and wage rates as
the price paid for labor. Variations in wages
The Bureau of Labor Statistics issued these statistics
are influenced by differences in workers™
on workers between the ages of 16 and 24, who were
skills and nonmonetary differences in jobs.
employed in July 1998: “About 7 in 8 employed youth Examine the cartoon below. Explain what
were wage and salary workers in the private sector this economists mean by a “competitive” salary.
summer, with retail trade (7.4 million) and services
(5.8 million) the largest employers. There also were
sizable numbers of youth employed in manufacturing
(2.2 million) and construction (1.2 million). Govern-
ment employed a total of 1.5 million young people in
July. Nearly 3 in 5 of the young people with govern-
ment jobs were employed in local governments.”
1. Total the number of individuals employed in
retail, services, manufacturing, construction, and
government.
2. Use the data to create a circle graph that illustrates
the percentages of individuals ages 16“24 in the
different economic sectors. Practice and assess key social studies skills with
the Glencoe Skillbuilder Interactive Workbook,
Level 2.

CHAPTER 8: EMPLOYMENT, LABOR, AND WAGES 221
Have you wondered or
questioned why the
paychecks you™ve seen have so
many deductions? In Chapter 9,
you will learn more about taxes
and revenues raised by all levels
of government. To learn about
the different types of taxes
collected by state and federal
governments, view the Chapter
15 video lesson:
How Government Collects




Chapter Overview Visit the Economics: Principles
and Practices Web site at epp.glencoe.com and
click on Chapter 9”Chapter Overviews to preview
chapter information.




While governments receive revenue
from a variety of sources, the most
important source is taxes.
The Economics of Taxation
Main Idea Key Terms
Taxes are the single most important way of raising sin tax, incidence of a tax, tax loophole, individual
revenue for the government. income tax, sales tax, benefit principle of taxation,
ability-to-pay principle of taxation, proportional tax,
average tax rate, progressive tax, marginal tax rate,
Reading Strategy
regressive tax
Graphic Organizer As you read the section, complete
a graphic organizer similar to the one below by list- Objectives
ing the criteria for taxes to be effective. Then, define After studying this section, you will be able to:
each of the criteria in your own words. 1. Explain the economic impact of taxes.
2. List three criteria for effective taxes.
3. Understand the two primary principles of taxation.
4. Understand how taxes are classified.
Taxes Applying Economic Concepts
Equity Read to find out what role equity, or fairness,
plays in administering taxes.




A
Cover Stor y
n enormous amount of money is required to
run the federal, state, and local governments
of the United States. In 1999, all three levels of
Tax Freedom Day government collected approximately $2.8 trillion”or
about $10,300 for every man, woman, and child in
[On] April 15, the United States. Whether we count the dollars, or
Tax
the
1999, the days needed to earn the dollars as illustrated in the
Foundation [made
cover story, it all adds up to a staggering sum.
public] its annual
Total revenue collections by all levels of government
calculation of Tax
have grown dramatically over the years. Figure 9.1
Freedom Day. It is
May 11th this year, shows that these revenues, even when adjusted for
the latest date ever. inflation and population growth, increased by nearly
nal
When Tax Freedom Many tax dollars go to natio 800 percent since 1940.
Day is May 11th defense.
untry,
across the co
what does that ld all
Economic Impact of Taxes
the government withhe
mean? It means that if rting
American™s paycheck sta
the money from every ing Taxes and other governmental revenues
uld have to continue do
on January 1, 1999, it wo ment
ct enough to fund govern influence the economy by affecting
so until May 11 to colle
resource allocation, consumer behavior, and the
at all levels.
nation™s productivity and growth. In addition, the
15, 1999
”Tax Foundation, April
burden of a tax does not always fall on the party
being taxed, because some of the tax can be trans-
ferred to others.

CHAPTER 9: SOURCES OF GOVERNMENT REVENUE 223
Figure 9.1

Total Government Receipts Per Capita, Adjusted for Inflation
800%
As a percentage of 1940 Dollars




700%

600%
1950 “1999 - Spending by
500%
all levels of government
1990s - Economic growth
increases 2.72% annually
400%
and higher marginal tax
rates contribute to
300%
increased revenues.
200%

100%
0%
1940 1950 1960 1970 1980 1990 2000
Source: Bureau of Economic Analysis and the Department of the Census, various forms

Using Graphs Total receipts by all levels of government have increased
significantly over time. What information does the graph show for
the period 1980 to 2000?
Visit epp.glencoe.com and click on
Textbook Updates”Chapter 1 for
an update of the data.


Resource Allocation Behavior Adjustment
The factors of production are affected whenever Often taxes are used to encourage or discourage
a tax is levied. A tax placed on a good or service at certain types of activities. For example, homeowners
the factory raises the cost of production, which are allowed to use interest payments on mortgages
shifts the supply curve to the left. If demand as tax deductions”a practice that encourages home
remains unchanged, the equilibrium price of the ownership. Interest payments on other consumer
product goes up. debt, such as credit cards, is not deductible”a
People react to the higher price in a predictable practice that makes credit card use less attractive.
manner”they buy less. When sales fall, some firms The so-called sin tax”a relatively high tax
cut back on production and some productive designed to raise revenue and reduce consumption of
resources”land, capital, labor, and entrepreneurs” a socially undesirable product such as liquor or
will have to go to other industries to be employed. tobacco”is another example of how a tax can be used
In 1991, for example, Congress enacted a luxury to change behavior. Canada used a sin tax in the
tax on expensive cars, private aircraft, yachts, and 1980s when it quadrupled the tobacco tax, pushing
other costly items in order to raise additional tax the price of a pack of cigarettes to more than $4, and
revenue from the wealthy. Because the demand for reducing cigarette consumption by one-third.
luxury goods was elastic, however, higher prices Efforts to tax tobacco in the United States, how-
drove customers away, and unemployment soared ever, show that tobacco, because of its addictive
in some of these industries. nature, is still an inelastic product. For example, it is

224 UNIT 3 MACROECONOMICS: INSTITUTIONS
ECONOMICS
estimated that a $1 tax per pack is not enough to sig-
Figure 9.2
nificantly affect consumption”and thus the govern- AT A GLANCE
AT A GLANCE
ment could raise billions of dollars in tax revenues.
Shifting the Incidence of a Tax
Productivity and Growth
A Elastic Demand
Finally, taxes can affect productivity and eco-
nomic growth by changing the incentives to save,
S + tax
invest, and work. Some people think that taxes are
D
already so high that it affects their incentive to
S
work. Why, they argue, should a person earn addi-
tional income if much of it will be paid out in taxes?
While these arguments have validity, it is difficult




Price
to tell if we have reached the point where taxes are $15.60
too high. For example, even the wealthiest individu- $15.00 $1 tax on
als pay less than half of their taxable income to state producer
and local governments in the form of income taxes. S + tax
D
Are these taxes so high that they do not have the
S
incentive to earn an additional $10 million because
they can only keep half? Would they work any harder 5 6
if income taxes only took thirty percent of their Quantity
income? Or, would they work just as hard if they paid
seventy percent of the extra income in taxes?
B Inelastic Demand
While we do not have exact answers to these
questions, we do know that there must be some S + tax
D
level of taxes at which productivity and growth
would suffer. This is just one of many reasons why Buyer pays S
90 cents more
people favor lower taxes. because of in-
elastic demand.
Price




The Incidence of a Tax $15.90
The party being taxed is not always the one that $15.00 $1 tax on
bears the burden of a tax. For example, suppose a producer
city wants to tax a local utility company to raise S + tax
revenue. If the utility is able to raise its rates, con-
S
sumers will likely bear most of the burden in the D
form of higher utility bills. If a company™s rates are 5.8 6
Quantity
regulated, and if the company™s profits are not large
enough to absorb the tax increase, shareholders
Using Graphs A tax on the producer in-
Using Graphs A tax on the producer in-
may receive smaller dividends”placing the burden
creases the cost of production and causes a
creases the cost of production and causes a
of the tax on the owners. Another alternative is that
change in supply. Less of the tax can be
change in supply. Less of the tax can be
the company may postpone a pay raise”shifting
shifted back to the taxpayer if demand is
shifted back to the taxpayer if demand is
the burden of the tax to its employees. elastic, as in A. More of the tax can be
elastic, as in A. More of the tax can be
The incidence of a tax”or the final burden of the shifted to the taxpayer if demand is
shifted to the taxpayer if demand is
tax”can be predicted with the help of supply and inelastic, as in B. Who is likely to bear
inelastic, as in B. Who is likely to bear
demand analysis. Examine the demand curve in the greater burden”the producer or
the greater burden”the producer or
Panel A of Figure 9.2. You see that it is relatively more the consumer”if a tax is placed on
the consumer”if a tax is placed on
elastic than the one shown in Panel B, although the medicine?
medicine?
supply curves are exactly the same in both. A $1 tax

CHAPTER 9: SOURCES OF GOVERNMENT REVENUE 225
You might believe that a tax is fair only if everyone
INFOBYTE pays the same amount. Your friend concludes, on
the other hand, that a tax is fair only if wealthier
people pay more than those with lower incomes.
Taxable Income Taxable income is the amount There is no overriding guide that we can use to
of income that is subject to taxation by the state
make taxes completely equitable. However, it does
and federal government. It is the adjusted gross
make sense to avoid tax loopholes”exceptions or
income of wages, salaries, dividends, interest,
oversights in the tax law that allow some people
capital gains, etc., less allowable adjustments
and businesses to avoid paying taxes. Loopholes
deductions, which include but are not limited to
are a fairness issue, and most people oppose them
contributions to retirement accounts, business
on the grounds of equity. Taxes generally are
expenses, and capital losses.
viewed as being fairer if they have fewer exceptions,
deductions, and exemptions.


Simplicity
on the producer in Panel A increases the price of the
A second criterion is simplicity. Tax laws should
product by 60 cents”which means that the producer
be written so that both the taxpayer and the tax col-
must have absorbed the other 40 cents. On the other
lector can understand them. This task is not easy,
hand, the demand curve in Panel B is relatively
but people seem more willing to tolerate taxes
inelastic. Here we can see that the exact same tax on
when they understand them.
the producer results in a 90-cent increase in price,
The individual income tax”the tax on people™s
which means that the producer must have absorbed
earnings”is a prime example of a complex tax.
the other 10 cents. The figure clearly shows that it is
The entire code is thousands of pages long, and
much easier for a producer to shift the incidence of a
even the simplified instructions the Internal
tax to the consumer if the consumer™s demand curve
Revenue Service (IRS) sends out to taxpayers are
is relatively inelastic. The more elastic the demand
lengthy and often difficult to understand. As a
curve, the greater the portion of the tax that will be
result, many people dislike the individual income
absorbed by the producer.
tax code, in part because they do not fully under-
In the case of the 1991 luxury tax on private air-
stand it.
craft, the burden of the tax fell on the producer
A sales tax”a general tax levied on most con-
because the demand for small private aircraft was
sumer purchases”is much simpler. The sales tax is
relatively elastic. The unemployment that resulted
paid at the time of purchase, and the amount of the
in the aircraft industry, along with the costs of cop-
tax is computed and collected by the merchant.
ing with the unemployment, convinced Congress
Some goods such as food, child care, and medicine
to remove the tax.
may be exempt, but if a product is taxed then every-
one who buys the product pays it.
Criteria for Effective Taxes
Some taxes will always be needed, so we
want to make them as effective as possible.
To do so, taxes must meet criteria: they must be
equitable, simple, and efficient.

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