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Equity Student Web Activity Visit the Economics: Principles
and Practices Web site at epp.glencoe.com and click
The first criterion is equity or fairness. Most peo- on Chapter 9”Student Web Activities for an activity
ple feel that taxes should be impartial and just. on the individual income tax.
Problems arise, however, when we ask, what is fair?

226 UNIT 3 MACROECONOMICS: INSTITUTIONS
Efficiency private aircraft in 1991. According to the IRS, only
$53,000 in luxury tax revenues were collected that
A third criterion for an effective tax is efficiency.
year because so few planes were sold. This turned
A tax should be relatively easy to administer and
out to be less than the unemployment benefits
reasonably successful at generating revenue.
paid to workers who lost jobs in that industry. This
The individual income tax satisfies this require-
is the reason Congress quickly repealed the luxury
ment fairly well. Whenever someone is paid, the
tax on small aircraft.
employer withholds a portion of the employee™s
pay and sends it to the IRS. At the end of the year,
the employer notifies each employee of the
Two Principles of Taxation
amount of tax withheld. Because most payroll
records are now computerized, neither the Taxes in the United States are based on two
employer nor the employee is unduly burdened by principles that have evolved over the years.
this withholding system. These principles are the benefit principle and the
Other taxes, especially those collected in toll ability-to-pay principle.
booths on state highways, are considerably less
efficient. The state invests millions of dollars in heav-
Benefit Principle
ily reinforced booths that span the highway. The cost
to commuters, besides the toll, is the wear and tear Many taxes are based on the benefit principle of
on their automobiles. After giving a few quarters and taxation: Those who benefit from government
dimes to the attendant, drivers take off again to goods and services should pay in proportion to the
repeat the process a few miles down the road. amount of benefits they receive.
Efficiency also means that the tax should raise Think about the taxes you pay for gasoline.
enough revenue to be worthwhile. If it does not, or Because the gas tax is built into the price of gaso-
if it harms the economy in other ways, the tax has line at the pump, people who drive more than
little value. One example is the luxury tax on small others pay more gas taxes”and therefore pay for


Principles of Taxation




Ability-to-Pay The veterinarian (left) and the firefighters (right) both have to pay taxes. According to
the ability-to-pay principle, how is the amount each person has to pay determined?


CHAPTER 9: SOURCES OF GOVERNMENT REVENUE 227
more of the upkeep of our nation™s highways. owners who profit from tourists arriving by car or
Taxes on truck tires operate on the same principle. bus? These people may buy very little gasoline, but
Because heavy vehicles like trucks are likely to put they still benefit from the facilities that the gas tax
the most wear and tear on roads, the tire tax is helps provide.
another way to tie the cost of repair and upkeep
to the user.
Ability-to-Pay Principle
The benefit principle has two limitations. The
first is that many government services provide the The second principle is the ability-to-pay
greatest benefit to those who can least afford to pay principle of taxation”the belief that people
for them. People who receive welfare payments or should be taxed according to their ability to pay,
live in subsidized housing, for example, usually regardless of the benefits they receive. An example
have the lowest incomes. Even if they could pay is the individual income tax, which requires indi-
something, they would not be able to pay in pro- viduals with higher incomes to pay more than
portion to the benefits they receive. those with lower incomes.
The second limitation is that the benefits often The ability-to-pay principle is based on two fac-
are hard to measure. Are people who pay for gas tors. First, it recognizes that societies cannot always
the only ones who benefit from the roads built measure the benefits derived from government
with gas taxes? What about property owners whose spending. Second, it assumes that people with
property increases in value because of the higher incomes suffer less discomfort paying taxes
improved access? What about hotel and restaurant than people with lower incomes.




ECONOMICS
Figure 9.3
AT A GLANCE
AT A GLANCE

Three Types of Taxes
Type of Income of Income of
Summary
Tax $10,000 $100,000

City Occupational Tax City Occupational Tax As income goes up, the
Proportional $97.50 or .975% $975.00 or .975% percent of income paid
of income of income in taxes stays the same.
Federal Income Tax Federal Income Tax As income goes up, the
$1,000 paid in taxes, $25,000 paid in taxes, percent of income paid in
Progressive
or 10% of total income or 25% of total income taxes goes up.

As income goes, up the
State Sales Tax State Sales Tax
percent of income paid in
$5,000 in food and clothing $20,000 in food and clothing
taxes goes down.
Regressive purchases, taxed at 4% for a purchases, taxed at 4% for a
total tax of $200 or 2% total tax of: $800 or
of income. .8% of income


Using Tables Proportional, progressive, and regressive are the three main types of taxes. Under
which type of tax do individuals with lower incomes pay a smaller percentage than do
those with higher incomes?


228 UNIT 3 MACROECONOMICS: INSTITUTIONS
For example, a family of four with an annual tax- A progressive tax is a tax that imposes a higher
able income of $20,000 needs every cent to pay for percentage rate of taxation on persons with higher
necessities. At a tax rate of 14 percent, this family incomes. A progressive tax claims not only a larger
pays $2,800”a huge amount for them. On the absolute (dollar) amount but also a larger percentage
other hand, a comparable family with a $100,000 of income as income increases. Progressive taxes
taxable income could afford to pay a higher tax rate usually use a marginal tax rate, the tax rate that
and suffer much less discomfort. applies to the next dollar of taxable income, that
increases as the amount of taxable income
increases. Therefore, the percentage of income paid
Types of Taxes in taxes increases as income goes up.
Three general types of taxes exist in the United Suppose the tax system requires a person to
States today”proportional, progressive, and pay $1,000 on $10,000 of taxable income, $4,000
regressive. Each type of tax is classified according to on $20,000 of taxable income, or $30,000 on
the way in which the tax burden changes as income $100,000 of taxable income. The tax is progressive
changes. over this range because the percent of income
A proportional tax imposes the same percentage paid in taxes”10, 20, and 30 percent respectively”
rate of taxation on everyone, regardless of income. If rises as income rises.
the income tax rate is 20 percent, an individual with A regressive tax is a tax that imposes a higher
$10,000 in taxable income pays $2,000 in taxes. A percentage rate of taxation on low incomes than
person with $100,000 in taxable income pays on high incomes. For example, a person with an
$20,000. annual income of $10,000 may spend $5,000 on
If the percentage tax rate is constant, the average food and clothing, while another person with an
tax rate”total taxable income divided by the total annual income of $100,000 may spend $20,000
income”is constant, regardless of income. If a per- on the same essentials. If the state sales tax is 4
son™s income goes up, the percentage of total income percent, the person with the lower income is pay-
paid in taxes does not change. ing a higher percentage of total income in taxes.




Checking for Understanding Applying Economic Concepts
1. Main Idea Using your notes from the graphic 7. Equity Which of the two principles of taxa-
organizer activity on page 223, list the ways tion”the benefit principle or the ability-to-
that taxes influence the economy. pay principle”do you feel is the most
equitable? Explain your answer. Be sure
2. Key Terms Define sin tax, incidence of a tax,
to include in your answer how the two
tax loophole, individual income tax, sales tax,
principles differ from one another.
benefit principle of taxation, ability-to-pay
principle of taxation, proportional tax, aver-
age tax rate, progressive tax, marginal tax
rate, regressive tax.
8. Drawing Inferences Think about the last
3. Describe the economic impact of taxes.
tax you paid. Using the criteria for progres-
4. List three criteria used to evaluate taxes.
sive, proportional, and regressive taxes,
5. Summarize the two main principles of taxation. determine which type of tax you think it is
and explain why.
6. Explain the characteristics of proportional,
progressive, and regressive taxes. Practice and assess key social studies skills with
the Glencoe Skillbuilder Interactive Workbook,
Level 2.



CHAPTER 9: SOURCES OF GOVERNMENT REVENUE 229
Using Library Resources
Your teacher has assigned a major research report, so you go to the library.
As you wander the aisles surrounded by books, you wonder: Where do I start
my research? Which reference works should I use?


Card Catalogs Every library has a card catalog, either on
cards or computer or both, which lists every book in the
library. Search for books by author, subject, or title.
Computerized card catalogs will also advise you on the
book™s availability.
Periodical Guides A periodical guide is a set of books
listing topics covered in magazines and newspaper
articles.
Computer Databases Computer databases provide collec-
tions of information organized for rapid search and
retrieval. For example, many libraries carry reference
materials on CD-ROM.
Internet Libraries can often suggest clearinghouse sites,
Deciding where to start your research online databases, and other reputable sites.
and which reference works to use are
important in doing a research report.
Practicing the Skill
Suppose you are assigned a research report dealing with
Learning the Skill the introduction of the U.S. income tax. Read the
Libraries contain many resources. Here are brief questions below, then decide which of the sources
descriptions of important ones: described above you would use to answer each question
and why.
Reference Books Reference books include encyclo-
pedias, biographical dictionaries, atlases, and 1. During which year was the federal income tax
almanacs. established?
• An encyclopedia is a set of books containing short 2. What was the purpose of the income tax when it was
articles on many subjects arranged alphabetically. introduced in 1913?
•A biographical dictionary includes brief biogra- 3. How did the public react to the tax?
phies listed alphabetically by last names.
• An atlas is a collection of maps and charts for
locating geographic features and places. An atlas
can be general or thematic.
Using library resources, research the origins of
• An almanac is an annually updated reference that Social Security taxes. Present the information you
provides current statistics and historical informa- find to the class.
tion on a wide range of subjects.
Practice and assess key social studies skills with the
Glencoe Skillbuilder Interactive Workbook, Level 2.
230 UNIT 3 MACROECONOMICS: INSTITUTIONS
The Federal Tax System
Main Idea tax, corporate income tax, excise tax, luxury good,
The federal government raises revenue from a variety estate tax, gift tax, customs duty, user fee
of taxes.
Objectives
Reading Strategy
After studying this section, you will be able to:
Graphic Organizer As you read the section, complete
1. Explain the progressive nature of the individual
a graphic organizer like the one below to identify the
income tax.
federal government™s most important revenue sources.
2. Describe the importance of the corporate tax
structure.
Revenue
3. Identify other major sources of federal revenue.
sources

Applying Economic Concepts
Federal Taxes You, the American taxpayer, are the
Key Terms source of most of the money the government spends.
Almost all federal government revenue comes from
payroll withholding system, Internal Revenue Service
taxation.
(IRS), tax return, indexing, FICA, medicare, payroll




T
he federal government collects taxes from a
Cover Stor y number of sources. The most important
sources of government revenue are individual
The Costs of Taxation income taxes, Social Security taxes, and corporate
income taxes.
Taxes are often a
l
source of heated politica
r
debate. In 1776 the ange Individual Income Taxes
es
of the American Coloni
d
over British taxes sparke In 1913 the Sixteenth Amendment to the
n.
the American Revolutio United States Constitution was ratified,
s
More than two centurie allowing Congress to levy an income tax. The
s
later Ronald Reagan wa amendment states that:
a
elected president on
in
platform of large cuts The Congress shall have power to lay and
s,
personal income taxe collect taxes on incomes, from whatever source
s
and during his eight year derived, without apportionment among the
American colonists
e White House the
in th protested against British several States, and without regard to any
tax rate on income taxes and collectors.
top census or enumeration.
t to 28
fell from 70 percen
ll
percent. In 1992 Bi Since the amendment was ratified, the federal
rt because incumbent
ton was elected in pa government has relied heavily on the individual
Clin ,
s 1988 campaign promise
rge Bush had broken hi income tax”the tax on people™s earnings”to
Geo
taxes.”
“Read my lips: no new finance its operations. As Figure 9.4 shows, the
Microeconomics, 1998
”N. Gregory Mankiw, federal government collected about 48 percent of
its total revenue from taxes on people™s earnings.

CHAPTER 9: SOURCES OF GOVERNMENT REVENUE 231
Payroll Deductions deductions and expenses that lower the amount of
taxes owed, as well as by additional income received
In most cases, the individual income tax is paid
that was not subject to tax withholding.
over time through a payroll withholding system, a
People who are self-employed do not have
system that requires an employer to automatically
money withheld from their paychecks. Instead,
deduct income taxes from an employee™s paycheck
they are required to send quarterly estimates of
and send it directly to the government. The agency
their taxes to the Internal Revenue Service. These
that receives the tax payment is the Internal
individuals must also make a final settlement for
Revenue Service (IRS), the branch of the U.S.
the previous year sometime before April 15.
Treasury Department in charge of collecting taxes.
After the close of the tax year on December 31,
A Progressive Income Tax
and before April 15 of the following year, the
The individual income tax is a progressive tax.
employee files a tax return”an annual report to the
According to the individual tax tables shown in
IRS summarizing total income, deductions, and the
Figure 9.5, single individuals paid a flat 15 percent
taxes withheld by employers. Any difference
on all income up to $26,250. After that, the mar-
between the amount already paid and the amount
ginal tax rate jumps to 28 percent, 31 percent, 36
actually owed, as determined by official tax tables
percent, and 39.6 percent, depending on the
like those shown in Figure 9.5, is settled when the
amount of taxable income. The tax schedule is
return is filed. Most differences are caused by




Figure 9.4

Federal Government Revenues by Source
30.3% Social Insurance Taxes 33.8%
& Contributions
1990 2000
7.5% Corporate Income Tax 10.1%

2.8% Excise Taxes 3.7%

1.3% Customs Duties 1.0%

0.9% Estate and Gift Taxes 1.4%
17.7% Borrowing

2.2% Miscellaneous 2.2%

37.3% Individual Income Tax 47.8%
Source: Budget of the United States Government and Economic Report of the President, various years

Using Graphs During the 1990s, individual income taxes were made more progressive, Social
Graphs
Security taxes were raised on the wealthiest recipients, and strong economic growth generated
higher corporate tax collections. These occurrences reduced the
government™s need to borrow. How did government borrowing
change between 1990 and 2000?
Visit epp.glencoe.com and click on
Textbook Updates”Chapter 9 for
an update of the data.


232 UNIT 3 MACROECONOMICS: INSTITUTIONS
ECONOMICS
Figure 9.5
AT A GLANCE
AT A GLANCE

Tax Table for Single Individuals
If the amount on Form enter on Form 1040,
of the amount over . . .
1040, line 39, is over . . . line 40
but not over . . .
$0 $26,250 ----------- 15% $0
$26,250 $63,550 $3,937.50 + 28% $26,250
$63,550 $132,600 $14,381.50 + 31% $63,550
$132,600 $288,350 $35,787.00 + 36% $132,600
$288,350 ----------- $91,853.00 + 39.6% $288,350
Source: Schedule X, IRS Individual Tax Table

Using Tables According to the individual income tax table, a single individual with $20,000 of
taxable income would pay $20,000 x .15, or $3,000 in taxes. How much in taxes would an
individual with $40,000 of taxable income pay?



similar for married individuals, with rates scaled so adjusted upward by 5 percent, the 28 percent mar-
that couples earning higher incomes pay a larger ginal rate for the year 2001 would not apply until
percentage of their income in taxes. $27,563 is earned.
When a tax is progressive, the average tax rate goes
FICA Taxes
up when income goes up. Figure 9.6 illustrates this
point. The single individual with $10,000 of taxable
The second most important federal tax is
income pays an average of 15 cents for every dollar
FICA. FICA is the Federal Insurance
earned. If the person has $35,000 of taxable income,
Contributions Act tax levied on both employers
the marginal tax rate is higher (at 28 percent), which
and employees to pay for Social Security and
raises the average tax on every dollar to 18.3 cents.
medicare. Medicare is a federal health-care pro-
Likewise, the individual with $145,000 of taxable
gram available to all senior citizens, regardless of
income pays an average of 27.8 cents on every dollar.
income. Employees and employers share equally in
paying the tax for Social Security and medicare.
Indexing These two taxes are also called payroll taxes
because they are deducted from your paycheck.
Suppose a worker receives a small raise, just
enough to offset the rate of inflation. Although
Social Security Taxes
that worker is no better off, the raise may still
push the worker into a higher tax bracket. In 2000 the Social Security component of FICA
Because of this possibility, the individual income was 6.2 percent of wages and salaries up to $76,200.
tax has a provision for indexing, an upward revi- After that amount, Social Security taxes are not
sion of the tax brackets to keep workers from pay- collected, regardless of income. This means that a
ing more in taxes just because of inflation. person with taxable income of $76,200 pays a
To illustrate, suppose that a single individual with Social Security tax of $4,724, the same as someone
no dependents had exactly $26,250 of taxable who earns $1,000,000.
income in 2000. If the person receives a 5 percent Because the Social Security tax is capped, it is
raise the following year to offset expected inflation, proportional up to $76,200, and regressive there-
the $1,313 raise would be taxed at the next marginal after. For example, a single individual with $76,200
tax bracket of 28 percent. The result is that the indi- of taxable income would pay an average of 6.2
vidual gets pushed into a higher tax bracket simply cents of Social Security taxes on every dollar
because of inflation. If the bracket is indexed, or earned (.062 times $76,200). If that same individual

CHAPTER 9: SOURCES OF GOVERNMENT REVENUE 233
ECONOMICS
Figure 9.6
AT A GLANCE
AT A GLANCE

Average Individual and FICA Taxes, Single Individuals, 2000
A Average Individual Income Tax
Tax in Cents per Dollar




$0.40
$0.35
$0.30
The average tax is
$0.25 $0.351 per dollar
At $150,000, the
$0.20 at $500,000.
average tax is $0.280.
$0.15
The 15% bracket
$0.10 ends at $26,250.
$0.05
$0.00
$2 $0

$5 00
$7 00
$1 000
$1 000
$1 000
$1 000

$2 000
$2 ,000
$2 000

$2 000
$3 000
$3 000
$3 000
$3 000

$4 000
$4 000
$4 000
$4 000
$5 000
00
0

0




,0
5,

0,
5,

,
,
,
,


,
,

,
,
,
,
,

,
,
,
,
00
25
50
75

00
25
50

75
00
25
50
75

00
25
50
75
00
Taxable Income

B Average FICA (Social Security & Medicare) Tax
$0.09
Tax in Cents per Dollar




$0.08
$0.07 Average FICA is
At $500,000,
only half as much
$0.06 average FICA
by $189,500.
$0.05 is $0.0239.
$0.04 After $76,200, no more
Social Security taxes are
$0.03 collected“so the
$0.02 average comes down.
$0.01
$0.00
$2 $0

$5 00
$7 00
$1 000
$1 000
$1 000
$1 000

$2 000
$2 ,000
$2 000

$2 000
$3 000
$3 000
$3 000
$3 000

$4 000
$4 000
$4 000
$4 000
$5 000
00
0

0




,0
5,

0,
5,

,
,
,
,


,
,

,
,
,
,
,

,
,
,
,
00
25
50
75

00
25
50

75
00
25
50
75

00
25
50
75
00 Taxable Income
Source: Internal Revenue Service

Using Graphs The individual income tax is a progressive tax, meaning that people with higher
incomes pay a larger percentage of that income as taxes than do persons with lower income. Is
the FICA tax a progressive or regressive tax? Explain your reasoning.



made $300,000, the average tax per dollar would major share of an eligible person™s total hospital
drop to 1.6 cents (.062 times $76,200 divided by bills. The medicare component of FICA is taxed at
$300,000). a flat rate of 1.45 percent. Unlike Social Security,
there is no cap on the amount of income taxed,
which means that wealthy individuals pay the same
Medicare percent of income to medicare taxes as do the poor.
When medicare and Social Security are consid-
In 1965 Congress added medicare to the Social
ered together, as in Panel B of Figure 9.6, we can
Security program. More than 30 million senior citi-
see the overall regressive nature of the FICA tax.
zens participate in medicare. The basic plan pays a

234 UNIT 3 MACROECONOMICS: INSTITUTIONS
For single individuals in 2000, the tax was level at In 1991 Congress expanded the excise tax to
7.65 percent up to $76,200, and then declined. A include certain luxury goods. An economic product
single individual earning $35,000 in 2000 paid an is called a luxury good (or service) if the demand for
average FICA tax of 7.65 cents per dollar. If that the good rises faster than income when income
same individual made $150,000, the average FICA grows. At first, the 19 percent luxury tax was
tax paid dropped to 4.60 cents per dollar. indexed to keep up with inflation and was applied
to many goods, including passenger vehicles in
excess of $30,000. The tax was unpopular, however,
Corporate Income Taxes so boats, aircraft, jewelry, and furs were dropped in
1993. Later, Congress decided to phase out the lux-
Corporations as well as individuals must pay ury tax by the year 2002.
income taxes. The third largest category of
taxes the federal government collects is the corporate
Estate and Gift Taxes
income tax”the tax a corporation pays on its profits.
An estate tax is the tax the government levies on
The corporation is taxed separately from individuals
the transfer of property when a person dies. Estate
because the corporation is recognized as a separate
taxes can range from 18 to 55 percent of the value
legal entity.
of the estate. Estates worth less than $650,000 were
Several marginal tax brackets, which are slightly
exempt in 1999, although this limit will soon be
progressive, are placed on corporations. The first is at
raised to $1,000,000.
15 percent on all income under $50,000. The second
The gift tax is a tax on donations of money or
is at 25 percent on income from $50,000 to $75,000.
wealth and is paid by the person who makes the gift.
The third tax bracket is at 34 percent on income start-
The gift tax is used to make sure that wealthy peo-
ing at $75,000. Eventually, a 35 percent marginal tax
ple do not try to avoid taxes by giving away their
applies to all profits in excess of $18.3 million.
estates before their deaths. As shown in Figure 9.4,
these two taxes account for only a small fraction of
Other Federal Taxes total federal government revenues.

In addition to income, FICA, and cor-
porate taxes, the federal government Federal Taxes
receives revenue in the form of excise taxes,
estate and gift taxes, and customs duties.


Excise Taxes
The excise tax”a tax on the manufacture
or sale of selected items, such as gasoline and
liquor”is the fourth largest source of federal
government revenue. The Constitution per-
mits levying excise taxes, and since 1789
Congress has placed taxes on a variety of
goods. Some early targets for excise taxes
were carriages, snuff, and liquor. Today, fed-
eral excise taxes also are found on telephone
services, tires, legal betting, and coal.
Excise Taxes The Constitution permits levying excise
Because low-income families spend larger
taxes. Since 1789 Congress has placed taxes on a variety
portions of their incomes on these goods
of goods, including gasoline, coal, and luxury goods.
than do high-income families, excise taxes What are luxury goods?
tend to be regressive.

CHAPTER 9: SOURCES OF GOVERNMENT REVENUE 235
The estate tax and the gift tax are progressive user fees”charges levied for the use of a good or
taxes”the larger the estate or gift, the higher the tax service”have been suggested with increasing fre-
rate. In the year 2000, these two taxes accounted for quency. President Ronald Reagan was one of the
about 1.4 percent of federal government revenue. first presidents to aggressively push for user fees
instead of taxes.
These fees include entrance charges you pay to
Customs Duties visit national parks, as well as the fees ranchers pay
A customs duty is a charge levied on goods when their animals graze on federal land. These fees
brought in from other countries. The Constitution are essentially taxes based on the benefit principle;
gives Congress the authority to levy customs politicians just seem to think that we won™t recognize
duties. Congress can decide which foreign imports them as taxes if they call them “user fees” instead.
will be taxed and at what rate. Congress, in turn,
has given the president authority by executive
order to raise or lower the existing tariff rates by as
much as 50 percent. Many types of goods are cov-
E-Filing
ered, ranging from automobiles to silver ore. The
duties are relatively low, and they produce little There are benefits to filing taxes online. E-filing
federal revenue today, although they were the speeds up tax-processing time so that computer
largest source of federal government income prior users can get their refunds twice as fast as those
who mail in paper. E-filing also prevents errors,
to 1913.
since no IRS keypunchers are needed to type in
the information from paper returns. In 1998, 20
Miscellaneous Fees percent of taxpayers filed their tax returns
online. By the year 2007, the IRS hopes to have
Finally, about 1.9 percent of federal revenue is
80 percent of returns filed electronically.
collected through various miscellaneous fees. Since
the 1980s, when taxes were politically unpopular,




Checking for Understanding Applying Economic Concepts
1. Main Idea Using your notes from the graphic 6. Federal Taxes User fees have been compared
organizer activity on page 231, list the federal to taxes based on the benefit principle of tax-
government™s most important revenue ation. Define user fees in your own words.
sources. What are the pros and cons of having user
fees as a way to charge admission to national
2. Key Terms Define payroll withholding system,
parks?
Internal Revenue Service, tax return, indexing,
FICA, medicare, payroll tax, corporate income
tax, excise tax, luxury good, estate tax, gift
tax, customs duty, user fee.
3. Describe the progressive nature of the indi- 7. Categorizing Information Explain and use
vidual income tax. an example to explain the regressive nature
of the current FICA tax.
4. Identify the main marginal tax brackets in the
corporate income tax structure. 8. Finding the Main Idea What is indexing?
What is its purpose?
5. Describe the other sources of government
revenue. Practice and assess key social studies skills with
the Glencoe Skillbuilder Interactive Workbook,
Level 2.



236 UNIT 3 MACROECONOMICS: INSTITUTIONS
Adviser to a President:
Janet Yellen
(1946“)

Janet Yellen, former Chair of the
President™s Council of Economic
Advisers (CEA), has a knack for
explaining things. When she was a
student pursuing her Ph.D. in eco-
nomics in the early 1970s, the lec-
ture notes she took became a
legend in their own time. The
“Yellen Notes,” as they were known,
were passed around and became the
unofficial textbook for several gen-
A Powerful Economic
erations of graduate students.
As a member of the Board of sometimes searing”views put
Voice:
Governors of the Federal Reserve, forth in her many writings. Rivlin
she frequently briefed the White is a blunt and outspoken critic of
Alice Rivlin
House on labor markets and wel- budget deficits, and argues that
fare reform. As a result of these spending cannot be brought
(1931“)
encounters, President Clinton under control until Congress is
Alice Rivlin, founding director
knew just where to look when he willing to reform the politically
of the Congressional Budget Office
needed a new Chair for the CEA sensitive spending measures, such
(CBO), former Director of the
in early 1997. as pension systems, subsidies, and
Office of Management and Budget
As Chair of the CEA, Yellen™s other types of transfer payments.
(OMB) in the Clinton administra-
top priorities were a balanced fed- Rivlin is now a senior fellow for
tion, and former Vice Chair of the
eral budget and welfare reform, the Brookings Institute, a
Fed™s Board of Governors, is one of
including measures that would Washington-based research group.
the most respected economists in
punish fathers who do not support
Washington. As a seasoned profes-
their children. The distribution of
Examining the Profiles
sional with a wealth of experience,
income was another priority. “I™m
her knowledge of government
concerned about rising inequality
1. Making Comparisons Compare and
finance is virtually unparalleled.
of earnings and its long-term social contrast the work and views of Yellen
She has written extensively and
implications,” Dr. Yellen said. and Rivlin.
is known for the straightforward”
“Education is the answer.”
2. Synthesizing Information What sig-
nificance is there in the fact that both
Yellen and Rivlin are women?

CHAPTER 9: SOURCES OF GOVERNMENT REVENUE 237
State and Local Tax Systems
Main Idea Key Terms
State and local governments each rely on different intergovernmental revenue, property tax, tax assessor,
revenue sources. payroll withholding statement
Reading Strategy Objectives
Graphic Organizer As you read the section, complete After studying this section, you will be able to:
a graphic organizer like the one below by describing 1. Explain how state governments collect taxes and
why sales taxes are effective ways to raise revenue. other revenues.
2. Differentiate between state and local revenue
systems.
3. Interpret paycheck deductions.

Applying Economic Concepts
Sales tax
Sales Tax Read to find out why, when you purchase
an item in most states, you pay a fee in the form of a
sales tax.




S
tate and local governments, like the federal
Cover Stor y government, raise revenue in many ways. They
receive funds from sales taxes, property taxes,
Death Taxes Raise Ire utility revenues, and through other methods.
Sometimes, as we saw in the cover story, they even
s
As opposition grow tax us when we die.
all
against the death tax, sm
the
business is emerging as
levy™s leading adversary.
State Government Revenue Sources
v-
A decade of strong re
luses
enues and record surp State governments collect their revenues from
ral
already threatened fede several sources. Figure 9.7 shows the relative
s, a
and state death taxe Will death taxes doom proportions of each source, the largest of which are
ey family-run businesses?
on
meager government m examined below.
th.
source to begin wi
that
Furthering the cause is
rited assets. . . .
34 states don™t tax inhe Intergovernmental Revenues
ing
e varies greatly, includ
The state tax landscap
tes. . . . Death-tax
on inheritance and esta The largest source of state revenue is the cate-
both levies a tax-
ing the levy amounts to gory called intergovernmental revenue”funds
supporters say eliminat ople
point out that most pe
break for the rich. They collected by one level of government that are dis-
be eligible for
nate enough to even tributed to another level of government for
aren™t fortu
expenditures. States receive these funds from the
the tax.
e is] belief that death
r small businesses [ther
But fo federal government to help with expenditures on
rises from being
ent family-run enterp
taxes prev welfare, education, highways, health, and hospi-
..
passed down to heirs. . tals. As Figure 9.7 shows, they represent nearly
” CNNfn, April 13, 1999
one-quarter of all state revenues.

238
ECONOMICS
Figure 9.7
AT A GLANCE
AT A GLANCE

Sources of State and Local Government Revenue
23.8% Intergovernmental Revenue 34.2%

21.7% Sales Taxes 5.3%

17.7% Employee Retirement & Insurance 2.1%

13.9% Individual Income Tax 1.6%

3.9% Higher Education Fees Charges 0.6%

3.2% Corporate Income Tax 0.3%

3.0% Interest Earnings 3.4%

1.7% Hospital Fees 4.2%

1.1% Property Taxes 25.6%

0.8% Utility and Liquor Store 8.6%

9.3% Other 14.0%



State Governments Local Governments
Source: Statistical Abstract of the United States, 1999


Using Charts State and local governments have their own sources of
revenue. What are the two largest sources of state revenue?
Visit epp.glencoe.com and click on
Textbook Updates”Chapter 9 for
an update of the data.



Taxes and Fees The sales tax is the second largest source of rev-
The sales tax is a general tax levied on consumer enue for states, accounting for 21.7 percent of total
purchases of nearly all products. The tax is a per- revenues collected. Only five states”Alaska,
centage of the purchase price which is added to the Delaware, Montana, New Hampshire, and Oregon”
final price the consumer pays. Merchants collect the do not have a general sales tax.
tax at the time of sale. The taxes are then turned over Many states levy taxes, fees, or other assessments
to the proper state government agency on a weekly on their employees to cover the cost of state retire-
or monthly basis. Most states allow merchants to ment funds and pension plans. Figure 9.7 shows
keep a small portion of what they collect to com- that employee retirement contributions were the
pensate for their time and bookkeeping costs. third largest source of state revenue.

CHAPTER 9: SOURCES OF GOVERNMENT REVENUE 239
On average, the fourth largest source of state among states still exist. For years, New Hampshire
revenues is the individual income tax. Overall, indi- took pride in the fact that it had neither a sales tax
vidual income tax revenues are about five times as nor an income tax. Even so, as Figure 9.8 shows,
large as the income tax collected from corporations. the state made up the difference with other types of
taxes. The same is true for Alaska, Delaware,
Montana, and Oregon”the other four states with-
Other Revenues out a general sales tax.
The remaining revenues that state governments
collect are interest earnings on surplus funds;
The Choice of Tax
tuition and other fees collected from state-owned
colleges, universities, and technical schools; corpo- The choice of tax is something that most states
rate income taxes; and hospital fees. feel strongly about. Sooner or later, however, they
Note that while the percentages in Figure 9.7 are all discover that if they do not use one kind of tax,
representative for most states, wide variations then they have to rely on another. In the end, the


ECONOMICS
Figure 9.8
AT A GLANCE
AT A GLANCE

State and Local Taxes as a Percentage of State Income
13.34

11.92
11.77
10.70 10.67 13.60
13.13
11.25 10.99 6.52
13.52
10.62
11.70
Alaska 6.09 7.89
11.39
10.74
11.31
11.46
11.27 11.93
11.36
11.00
11.04
12.70 12.85
10.81
10.81
11.40
11.59 10.32
U.S. average 11.99 11.66 11.94 11.11
11.45%
10.77 11.12
8.61
11.01 10.67
12.38 18.10
11.63
11.51
12.34 11.50
9.47
10.52


10.65
10.20
Hawaii 14.19%


Source: Tax Foundation

Using Maps State and local governments receive revenue from a
number of sources. The five states without sales taxes”Alaska,
Delaware, Montana, New Hampshire, and Oregon”rely on other taxes
to provide state revenues. What states have the highest level of
Visit epp.glencoe.com and click on
state and local taxes? The lowest level?
Textbook Updates”Chapter 9 for
an update of the data.



240 UNIT 3 MACROECONOMICS: INSTITUTIONS
ECONOMICS
choices that states face are like the
Figure 9.9
AT A GLANCE
AT A GLANCE
choices individuals face”and we
already know that there is no such
Biweekly Paycheck and
thing as a free lunch.
Nearly three-fourths of the states
Withholding Statement
run public lotteries to raise rev-
enue. Lotteries became the fastest-
growing source of state revenues in 21-2
Weaver & Higginson 2,195,903
Number
000
the 1980s. The states spend about Attorneys at Law
Date June 25 19 99
half the lottery income on prizes Pay to the
˜
Sara Pena
and 6 percent on administration. 586.89
$
order of
Five Hundred Eighty-Six Dollars and 89/100
Dollars
Local Government THE CENTRAL BANK
Memo
Revenue Sources Treasurer

The major sources of local
PLEASE DETACH AND RETAIN THIS PORTION
government revenue are also AS YOUR RECORD OF EARNINGS AND DEDUCTIONS
shown in Figure 9.7. These include Date Pay End Vo. Emp. Hrs. Misc. Cr. Ins. Gross
taxes and funds from state and fed- No. No. Un.
eral governments. The main cate- 6/7/99 6/18/99 1376 80 3.20 800 00
gories are discussed below.
104 70 40 01 4 00 61 20 586 89

Intergovernmental Federal State City FICA Ret. Bonds Other Net

Revenues
Local governments receive the Understanding Percentages The withholding statement
attached to your paycheck
largest part”slightly more than attached to your paycheck Federal, state, and the federal,
summarizes many of the summarizes many of local taxes.
one-third”of their revenues in the state, and local taxes. Federal and state are always shown,
Federal and state income tax withholdings income tax with-
form of intergovernmental trans- holdings are always shown, as is the FICA (Social Security and
as is the FICA (Social Security and medicare) tax. Other
fers from state governments. These medicare) tax.may include city income taxes and voluntary
withholdings Other withholdings may include city income
funds are generally intended for taxes and voluntaryhealth insurance payments and savings
deductions, such as deductions, such as health insurance
payments and savings plans. What percentage ofbeen
plans. What percentage of this individuals pay has this
education and public welfare. A
individual™s pay has been deducted from her paycheck?
deducted from her paycheck?
much smaller amount comes
directly from the federal govern-
ment, mostly for urban renewal.

Property Taxes purposes”know the reasonable value of everyone™s
wedding silver, furniture, coin collections, cloth-
The second largest source of revenue for local
ing, and other tangible property items? Instead,
governments is the property tax”a tax on tangible
most communities find it more efficient to hire
and intangible possessions such as real estate,
one or more individuals to assess the value of a few
buildings, furniture, automobiles, farm animals,
big-ticket items like buildings, real estate, and
stocks, bonds, and bank accounts.
motor vehicles.
The property tax that raises the most revenue is
the tax on real estate. Taxes on other personal
property, with the exception of automobiles, is sel-
Other Sources
dom collected because of the problem of valua-
tion. For example, how would the tax assessor”the The third largest source of local revenue is
person who assigns value to property for tax derived from the earnings of public utilities and

CHAPTER 9: SOURCES OF GOVERNMENT REVENUE 241
state-owned liquor stores. Figure 9.7 shows that length of the workweek is 40 hours, the worker™s
local governments acquired 8.6 percent of their rev- gross pay amounts to $800. The worker is single, has
enues from these sources. no deductions, and lives and works in Kentucky.
Many towns and cities have their own sales According to withholding tables the federal gov-
taxes. Merchants collect these taxes right along with ernment supplied for that year, biweekly workers
the state sales tax, at the point of sale. As indicated making at least $800, but less than $820, have
in Figure 9.7, sales taxes are the fourth most impor- $104.70 withheld from their paychecks. Similar
tant source of local government revenues. tables for the state of Kentucky specify that $40.01
Local governments also collect a portion of is withheld for state income taxes. Because these
funds in the form of hospital fees and personal are both estimates, and because even minor differ-
income taxes. In general, the revenue sources avail- ences between the amounts withheld and the
able to local governments are much more limited amount actually owed can grow, the worker will file
than those available to the state and federal levels state and federal tax returns between January 1 and
of government. April 15 of 1998 to settle the differences.
Another deduction is the half-percent city
income tax that amounts to $4. Because the
amount is relatively small, cities seldom require
Examining Your Paycheck workers to file separate year-end tax forms.
The federal FICA tax amounts to 7.65 percent
Many of the taxes you pay to federal, state,
(6.20 percent for Social Security and 1.45 percent
and local governments are deducted directly
for medicare) of $800, or $61.20. The FICA is
from your paycheck. By examining the payroll
deducted from the gross pay, along with $3.20 in
withholding statement”the summary statement
miscellaneous deductions, which leaves the worker
attached to a paycheck that summarizes income,
with a net pay of $586.89.
tax withholdings, and other deductions”shown in
If the worker has insurance payments or retire-
Figure 9.9, we can identify many of the revenue
ment contributions, purchases savings bonds, or
sources described in this chapter.
puts money into a credit union, even more deduc-
The worker to whom the check belongs makes $10
tions will appear on the paycheck.
an hour and receives a check every two weeks. If the




Checking for Understanding Applying Economic Concepts
1. Main Idea Using your notes from the graphic 6. Sales Taxes Why do you think sales taxes are
organizer activity on page 238, write a defini- applied to food and beverages purchased at
tion in your own words of what intergovern- restaurants, but not to food and beverages
mental revenues are. purchased at grocery stores?
2. Key Terms Define intergovernmental rev-
enue, property tax, tax assessor, payroll with-
holding statement.
3. Explain the four major sources of state tax
7. Drawing Conclusions State and local gov-
revenues.
ernments receive revenue from various
4. Explain the difference between state and sources. Which source do you think best sat-
local revenue systems. isfies the tax criteria listed in the chapter?
Defend your answer.
5. List the major types of state, local, and fed-
eral taxes reflected on a paycheck. Practice and assess key social studies skills with
the Glencoe Skillbuilder Interactive Workbook,
Level 2.



242 UNIT 3 MACROECONOMICS: INSTITUTIONS
JANUARY 18, 1999
Newsclip
The Sixteenth Amendment, which gives
Congress the power to tax people™s
incomes to generate revenue for the fed-
eral government, was added to the
Constitution in 1913. Today, taxes are
placed on income, sales, and property to
raise money for services such as trans-
portation and education.

maintain consumption as highly exaggerated. In
Do Taxes Spell actuality, he notes, people have been spending
with exuberance. . . .
Good News? As for the rising tax take, Kasriel claims that
the main cause has been increases in inflation-
adjusted income, which have been pushing tax
Taxes, as the saying goes, may be as
filers into higher marginal brackets. . . .
unavoidable as death, but do they have to be
Similarly, more income has become subject
so high?
to taxation as more households have moved off
. . . In recent years, federal individual income welfare rolls and onto payrolls in response to
and payroll taxes have been claiming an ever welfare reform and a tight labor market. . . .
larger share of personal income. . . . Finally, Kasriel points to a development oth-
As some critics see it, this growing tax bite is ers have cited in explaining the falling savings
squeezing consumers. With more income being rate and rising tax bite: the huge increase in
siphoned off by taxes, they say, struggling house- household net worth generated by the stock mar-
holds have had to dip into savings simply to main- ket boom. With the value of their past savings
tain consumption patterns. And the fact that the and investments rising so rapidly, consumers
monthly savings rate recently turned negative for have felt free to curtail current savings so they
the first time in 60 years under- can enjoy the fruits of their past thrift now. . . .
scores the problem. ”Reprinted from January 18, 1999 issue of Business Week, by special
Does it? Economist permission, copyright © 1999 by The McGraw-Hill Companies, Inc.
Paul L. Kasriel of
Northern Trust Co.,
Examining the Newsclip
who has long favored
lower marginal tax 1. Making Inferences How would having negative
rates, is dubious. For monthly savings rates imply that taxes are too high?
one thing, he regards 2. Drawing Conclusions Do you agree with Paul
the picture of tax- Kasriel™s opinion about taxes and lower savings rates?
beleaguered house- Why or why not?
holds struggling to

CHAPTER 9: SOURCES OF GOVERNMENT REVENUE 243
Current Tax Issues
Main Idea Key Terms
The consequence of tax reform was to make the indi- accelerated depreciation, investment tax credit, sur-
vidual tax code more complex than ever. charge, alternative minimum tax, capital gains, value-
added tax (VAT), flat tax
Reading Strategy
Objectives
Graphic Organizer As you read the section, complete
a graphic organizer like the one below by listing the After studying this section, you will be able to:
1. Describe the major tax reforms since 1980.
advantages and the disadvantages of the flat tax.
2. Debate the advantages and disadvantages of the
Include a definition of flat tax in your own words.
value-added tax.
3. Explain the features of a flat tax.
Flat tax 4. Discuss why future tax reforms will occur.

Applying Economic Concepts
Flat Tax Have you ever noticed how much time your
Advantages Disadvantages
parents spend filling out their income tax returns?
Read to find out what a flat tax would mean to them.




T
he editorial in the cover story sums it up quite
Cover Stor y well. The complexity of our tax code is not
accidental: it is the result of adjustments and
is Way amendments by Congress to both influence and
How the Tax Code Got Th reward behavior.
e,
Every year at this tim
th a
Congress discovers, wi
Tax Reform in the 1980s and 1990s
smay
great public show of di
ence
and indignation, the exist
Tax reform has received considerable attention
and
of the American tax code
in recent years, due to more changes in the tax
ers it,
the agency that administ
rvice. code, and more changes in direction, than at any
the Internal Revenue Se
d
There are high-minde time in our nation™s history.
rrent
calls for abolishing the cu
it. . . .
tax system and replacing
Tax Reform in 1981
ss
Around April 15, Congre IRS employee sorts
that the tax
likes to pretend tax returns When Ronald Reagan was elected president in
appeared or
code just sort of 1980, he believed that high taxes were the main
t the
[just] happened. Bu -
en of taxes solely, exclu stumbling block to economic growth. Accordingly,
nstitution puts the burd
Co he proposed the Economic Recovery Tax Act of
ngress™ shoulders.
sively and entirely on Co of
it is because a majority 1981, which substantially reduced taxes for indi-
The tax code is the way is
y. Hope you enjoyed th viduals and businesses.
ngress wants it that wa
Co
Before the Recovery Act, the individual tax
year™s tax day.
code had 16 marginal tax brackets ranging from
n News, April 16, 1999
”Denver Rocky Mountai
14 percent to 70 percent. In comparison, today™s

244
tax code, shown in Figure 9.5, has five marginal were able to legally avoid paying taxes. Boeing,
brackets ranging from 15 to 39.6 percent. The 1981 ITT, General Dynamics, Transamerica, and
act lowered the marginal rates in all brackets, but, Greyhound were profitable from 1981 to 1984.
more importantly, it capped the highest marginal Instead of paying corporate income taxes, however,
tax wealthy individuals paid at 50 percent. these companies applied tax losses in earlier years
Businesses also got tax relief in the form of to current profits”and then collected tax refunds
accelerated depreciation”larger than normal during each of those four years.
depreciation charges”which allowed firms to In 1986 Congress passed the most sweeping tax
reduce federal income tax payments. Another sec- reform act since income taxes were enacted in 1913.
tion of the act introduced the investment tax First, it ended the traditionally progressive individ-
credit”a reduction in business taxes that are tied to ual income tax structure by reducing the 16 mar-
investment in new plant and equipment. For exam- ginal tax brackets to two brackets (essentially the
ple, a company might purchase a $50,000 machine 15 percent and 28 percent brackets in Figure 9.5).
that qualified for a 10 percent, or $5,000, tax credit. Then, a 5 percent surcharge”or additional tax
If the firm owed $12,000 in taxes, the credit above and beyond the base rate”was added to bring
reduced the tax owed to $7,000. the top bracket to 31 percent.
These provisions produced a dramatic impact on The law also made it difficult for the very rich to
the federal budget. In 1980, the proportion of total avoid taxes altogether. The alternative minimum
federal government revenues from the corporate tax”the personal income rate that applies when-
income tax was 12.5 percent. This dropped to 10.2 ever the amount of taxes paid falls below some des-
percent in 1981, and then to 8.0 percent in 1982, ignated level”was strengthened. Under this
and finally to 6.2 percent in 1983. provision, people had to pay a minimum tax of
20 percent, regardless of other circumstances or
loopholes in the tax code.
Tax Reform: 1986, 1993 Finally, the reform act shifted about $120 billion
By the mid-1980s, the idea that the tax code of taxes from individuals to corporations over a
favored the rich and powerful was gaining momen- five-year period by removing a number of tax breaks
tum. In 1983 more than 3,000 millionaires paid no for business. As a result, the proportion of total fed-
income taxes. Additionally, many corporations eral government revenues from the corporate



Taxation




Reform Some people think any tax is too high, but this viewpoint is not very realistic. What tax credits
were part of the Taxpayer Relief Act of 1997?


CHAPTER 9: SOURCES OF GOVERNMENT REVENUE 245
income tax increased to 9.8 percent in 1987, and to In the end, an analysis by the United States
10.3 percent in 1988”percentages much closer to Treasury Department determined that nearly half
the 10.1 percent shown in Figure 9.4. of the benefits went to the top 20 percent of wage
As the United States entered the 1990s, the impact and income earners. The lowest 20 percent
of 10 years of tax cuts was beginning to show. received less than 1 percent of the tax reductions.
Government spending was growing faster than With all its categories, the 1997 federal tax law
revenues, and the government had to borrow more. became the most complicated ever.
The Omnibus Budget Reconciliation Act of 1993
was driven more by the need for the government to
The Value-Added Tax
balance its budget than to overhaul the tax brackets.
As a result, the law added the two top marginal tax Some people want to change the personal
brackets of 36 and 39.6 percent, shown in Figure 9.5. income tax; others want to scrap it alto-
gether. One controversial proposal is to shift the
tax from income to consumption. This shift would
Tax Reform in 1997 be accomplished with the use of a value-added tax
In 1997 the largest tax reduction since the 1981 (VAT)”a tax placed on the value that manufactur-
act was passed. The law was known as the ers add at each stage of production.
Taxpayer Relief Act of 1997, and the forces that The VAT has the potential to raise enormous
created it were both economic and political. amounts of revenues for the federal government.
On the economic side, the government found The United States currently does not have a VAT,
itself with unexpectedly high tax revenues in 1997. although it is widely used in Europe.
The higher marginal tax brackets introduced in
1993, along with the closure of some tax loopholes,
The Concept of Value Added
meant that individuals and corporations paid more
The production of almost any good or service
taxes than before. In addition, unexpectedly strong

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