. 13
( 33)


involves numerous steps. Consider wooden base-
economic growth resulted in an increased number
ball bats. First, loggers cut the trees and sell the
of people and businesses paying taxes.
timber to lumber mills. Then the mills process the
On the political side, the balance of power had
logs for sale to bat manufacturers. The manufac-
dramatically shifted in the 1996 elections. Both
turers then shape the wood into baseball bats.
political parties felt they had commitments to ful-
After the bats are painted or varnished, they are
fill to the people who had voted them into office.
sold to a wholesaler. The wholesaler sells them to
For many Republicans, this meant a tax break for
retailers, and retailers sell them to consumers. The
people with long-term investments in stocks,
whole process is illustrated in Figure 9.10. The first
bonds, and other assets. The tax on capital gains”
column of numbers shows the value added at each
profits from the sale of an asset held for 12
stage of production. With the VAT, the consumer
months”was reduced from 28 to 20 percent.
ends up paying $11 for each bat.
Inheritance taxes”the so-called “death taxes” dis-
cussed in the cover story on page 244”were also
lowered, which tended to favor the well-to-do.
The tax reductions reflected the “family-friendly”
theme of the 1996 elections. Tax credits of $500 per
child and other deductions for educational expenses Tax Freedom Day It takes 40 days, on average, for
were included in the legislation. The marginal tax most Americans to earn enough money to pay for
brackets in Figure 9.5 remained unchanged, how- their food supply for the entire year. It takes the
average American 129 days”until the second week
ever, which resulted in an unbalanced distribution
of May”to earn enough money to pay federal,
of tax cuts. People who had neither children nor
state, and local taxes for the year.
capital gains from the sale of houses, stocks, or
bonds received virtually no benefit.

Advantages of a VAT Finally, some supporters claim that the VAT
would affect people™s behavior in a manner that
As a way of raising revenue, the VAT has several
encourages them to save more than they do now.
advantages. First, it is hard to avoid because the tax
After all, if none of your money is taxed until it is
collector levies it on the total amount of sales less
spent, you might prefer to spend less”and save
the cost of inputs. Second, the tax incidence is
more”than you do now.
widely spread, which makes it harder for a single
firm to shift the burden of the tax to another
Disadvantages of a VAT
The main disadvantage of the VAT is that it
Third, the VAT is easy to collect because firms
tends to be invisible to consumers. In the baseball
make their VAT payments to the government along
bat example, consumers may be aware that bat
with their regular tax payments. Consequently,
prices went from $10 to $11, but they might attrib-
even a relatively small VAT can raise a tremendous
ute this to a shortage of good wood, higher wages,
amount of revenue, especially when it is applied to
or some other factor. In other words, consumers
a broad range of products.

Figure 9.10

The Value-Added Tax
No Taxes With a 10% Value -Added Tax
Value Cumulative Value Added Value
Added Value with a 10% VAT with VAT
Loggers fell trees and sell the timber
$1 $1 $1 + $.10 = $1.10 $1.10
to the mills for processing.

The mills cut the timber into blanks
$1 $2 $1 + $.10 = $1.10 $2.20
that will be used to make bats.

Bat manufacturers shape, paint, or
varnish the bats and sell them $5 $7 $5 + $.50 = $5.50 $7.70
to wholesalers.

The wholesalers sell the bats to retail
$1 $8 $1 + $.10 = $1.10 $8.80
outlets where consumers can buy them.

The retailers put the bats on the shelves
$2 $10 $2 + $.20 = $2.20 $11.00
and wait for the consumers.

The consumer buys the bat for: $10.00 $11.00

Using Tables The VAT is like a national sales tax added to each stage of production. As a result, it is
built into the final price of a product and is less visible to consumers. Is a VAT regressive,
proportional, or progressive? Why?

Tax Revenues as a % of GDP
55% France
45% U.K.
35% Germany
The ratio of tax revenues to the GDP is one meas-
ure of a country™s tax burden. ™89 ™91 ™93 ™95 1997
Have you ever thought about living in another
Source: A Citizen™s Guide to the
country to avoid high taxes in the United States? If Federal Budget, FY 2000
you did move, you would be in for a surprise. For all
the complaints about high taxes, our federal gov-
Critical Thinking
ernment™s revenues as a percentage of GDP are
much lower than many people realize. In fact, the 1. Analyzing Information What is measured
rate is one of the lowest in the industrial world. in the graph?
2. Sequencing Information Describe the pat-
tern for Canada from 1991 to 1996.

cannot be vigilant about higher taxes when they viewed the proposal as a way to provide tax breaks
cannot see them. for the wealthy. As a result, most flat tax proposals
Another difficulty is that the VAT would com- exempt some income.
pete with state sales taxes. Because the VAT is a Consider a 15 percent flat tax that exempts the
federal tax, adding a VAT is like adding a federal first $20,000 of income. According to this system,
sales tax to already-existing state taxes. If some of a person with exactly $20,000 pays nothing in
these bats were sold in Indiana, Arizona, or Texas, taxes, and therefore has a zero average tax rate.
would those states want to forgo their sales tax Someone who earns twice as much would pay
simply because a federal VAT was in place? Or nothing on the first $20,000, and 15 percent on the
would those states simply add their own sales next $20,000. Taxes would amount to $3,000, for
taxes, thereby raising the price to $11.50 or even an average tax rate of 7.5 percent ($3,000 divided
higher? by $40,000). Likewise, someone who earned
$60,000 would pay $6,000 (15 percent of $40,000),
and have an average tax rate of 10 percent ($6,000
The Flat Tax divided by $60,000).
Because the average tax in the example above”0,
The concept of a flat tax”a proportional tax 7.5, and 10 percent respectively”increases as
on individual income after a specified income increases, the tax is progressive. As a result,
threshold has been reached”did not receive much a flat tax can be progressive as long as some income
attention until Republican candidate Steve Forbes is exempted.
and others raised the issue in the 1996 presidential
elections. Supporters promoted the flat tax as a way
Advantages of the Flat Tax
to both simplify taxes and stimulate growth.
The primary advantage of the flat tax is the sim-
A “Progressive” Flat Tax? plicity it offers to the taxpayer. A person would still
have to fill out an income tax return every year, but
A pure flat tax would tax all income at a specific
many current procedures, such as itemizing deduc-
rate, such as 15 or 20 percent. Since the lowest tax
tions, could be skipped.
rate for all Americans is already 15 percent, critics

A second advantage is that a flat tax closes or the up-front exemption, is a dramatic shift away from
minimizes most tax loopholes. Under today™s tax the ability-to-pay principle of taxation.
code, for example, the donation of a single artwork
can substantially reduce a millionaire™s tax liability.
Flat Tax Proposals
A third advantage is that a flat tax reduces the
Several congressional candidates during the
need for tax accountants, tax preparers, and even
1996 election campaign presented various flat tax
large portions of the IRS. Overall, the savings to
proposals. Shortly after the election, Republican
everyone could be as high as $100 billion annually.
House Majority Leader Dick Armey presented his
version. Armey™s plan offered a 17 percent flat tax
Disadvantages of the Flat Tax
on individual income that would exempt the first
The first disadvantage of the flat tax is that it
$35,400 earned by a family of four. Businesses
removes many of the behavior incentives already
would also be subject to a 17 percent tax rate.
built into the tax code. For example, the current tax
Would taxpayers be better off under this pro-
code allows homeowners to deduct interest pay-
posal? The answer depends on how much you
ments on home mortgages. Other incentives
make and how you make it. For example, only
include deductions for donations to charitable
labor income from wages, tips, salaries, and pen-
organizations, and education and training.
sions would be taxed under the Armey plan.
Eliminating these incentives is likely to
Incomes from dividends, interest, and capital
encounter some resistance. For example, Money
gains are excluded. Critics argued that these exclu-
Magazine warned that a 15 percent flat tax would
sions”especially capital gains”favored the
hurt homeowners because they could no longer
deduct mortgage interest payments. The writer also
noted that, “under his own plan, multimillionaire
Steve Forbes could see his personal tax bill cut by
almost two-thirds.” This, of course, highlights the
second problem with the flat tax”namely that it
will benefit those with high incomes at the expense
Public Accountant
of lower-income individuals.
To illustrate, suppose that a single individual Accountants prepare, ana-
has $50,000 of taxable income and is subject to lyze, and verify financial
the tax rates shown in Figure 9.5. Taxes for this reports that provide infor-
individual would amount to $3,862.50 plus 28 mation to the general pub-
percent of the difference between $50,000 and lic and to business firms.
$25,750”for a total tax bill of $10,653. Under a 15
The Work
percent flat tax that exempts the first $40,000, the
They check clients™ financial
same individual would owe taxes of $1,500”a
records, ensuring that they
total tax saving of $9,153!
conform to standard proce-
On the other hand, if that same person had tax-
dures for reporting. They
able income of $1,000,000, the total amount of
give advice on tax advantages and disadvantages, on set-
taxes owed according to Figure 9.5 would be
ting up an accounting system and on managing cash
$374,073. Under the same 15 percent flat tax plan,
resources, and they prepare income tax statements.
the individual would owe $144,000 instead”for a
tax saving of $230,073. Qualifications
Who benefits the most? The person with a Most firms require applicants to have, at the minimum, a
$50,000 income who gets an 86 percent tax reduction bachelor™s degree in accounting or some closely related
and saves $9,153, or the person with a $1,000,000 field. Accountants must be good at mathematics, be able
income who gets a 61.5 percent tax reduction and to compare, analyze, and to interpret numbers and facts,
saves $230,073? Any flat tax, regardless of the size of and to make sound judgments.

House Minority Leader Dick Gephardt coun- First, the tax code is more complex now than
tered Armey™s proposal with a “10% Plan.” Under ever”a fact that guarantees future attempts to
Gephardt™s plan, a family of four would pay no simplify it. The flat tax movement, for example,
taxes on income up to $27,500, and then would pay has moved beyond the point of being a campaign
at a 10 percent rate up to $61,000. After that level, strategy to the stage where Congress is seriously
the marginal tax bracket would increase in incre- considering such a tax.
ments to the maximum rate of 34 percent. Second, the strong economy of the 1990s
Would a flat tax stimulate economic growth? resulted in record tax collections. For the first time
Critics point out that the extraordinary growth of the in 30 years, the government collected more rev-
American economy in the 1990s, the longest period enues than it spent. As a result, many political lead-
of peacetime prosperity in our history, sheds doubt ers began to consider ways to lower taxes.
on the claim that the current system hinders growth. Third, political change is not like economic
Second, no one knows exactly what rate is change, which is gradual and generally evolutionary.
needed to replace the revenues already collected Political change is more abrupt, with less continuity
under the current system. Estimates by economists from one period to the next, as one party leaves
who proposed the tax, as well as estimates done by office and another enters. New administrations
the United States Treasury, place the tax closer to often display a sense of urgency, a desire to finally
23 percent”which represents more of a burden on do things the “right” way, or to clean up the
low-income earners. excesses of their predecessors.
Yet, dramatic change is tempered by the reluc-
tance of politicians to give up some of the power
they currently exercise through the tax code”power
The Inevitability of Future Reforms vested in the ability to modify behavior, influence
resource allocation, support pet projects, and grant
There were more changes, additions, dele-
concessions to special interest groups. As the edi-
tions, exceptions, and exclusions made to
torial in the cover story aptly put it, “The tax code
the federal tax code in the 1980s and 1990s than at
is the way it is because a majority of Congress
any time in our history. Several factors ensure fur-
wants it that way.”
ther change.

Checking for Understanding Applying Economic Concepts
1. Main Idea What is the purpose of tax reform? 7. Flat Tax What do you think might happen to
donations to charitable organizations if there
2. Key Terms Define accelerated depreciation,
was a flat tax? If possible, support your
investment tax credit, surcharge, alternative
answer with examples.
minimum tax, capital gains, value-added tax,
flat tax.
3. Describe three major tax reform bills since
4. Explain the advantages and disadvantages of
8. Summarizing Information What changes
the VAT.
would you recommend in the federal tax
5. Describe the features of the flat tax. code if you were in charge of revising it?
Explain your answer.
6. Identify three forces that are likely to cause
future revision of the tax code. Practice and assess key social studies skills with
the Glencoe Skillbuilder Interactive Workbook,
Level 2.

Section 1 Section 3

The Economics of Taxation State and Local Tax Systems
(pages 223“229) (pages 238“242)
• •
Taxes affect the allocation of Intergovernmental revenues are the largest source
resources, behavior, and eco- of state revenues.
nomic growth.
• Local governments receive intergovernmental revenues
• The incidence of a tax, or final from state and federal governments. Local govern-
burden of a tax, is affected by ments also raise revenue from property taxes, utility
elasticity”when demand for a and liquor store sales, sales taxes, and other sources.
product is elastic, less of the
• The payroll withholding statement attached to a
tax can be shifted to the person™s weekly, biweekly, or monthly paycheck
buyer; more can be shifted when demand is inelastic. provides a summary of wages, taxes, and other
• Equity, simplicity, and efficiency are the criteria used withholdings.
to judge the effectiveness of a tax.
• Two principles, the benefit principle of taxation and
Section 4
the ability-to-pay principle of taxation, have been
used to help select the group or groups that bear the
Current Tax Issues (pages 244“250)
burden of the tax. Both involve value judgments,
and both types of taxes are widely used today.
• A value added tax (VAT) is a tax on consumption
• Taxes can be placed into three groups”proportional
rather than income. It is built into a product™s every
taxes, progressive taxes, and regressive taxes”
stage of production, is largely invisible, is regressive,
depending on the way in which the tax burden
and can raise huge sums.
changes as income changes.
• The Economic Recovery Tax Act of 1981 lowered
marginal tax rates for all levels of income, and added
accelerated depreciation and the investment tax
Section 2
credit for businesses.
The Federal Tax System (pages 231“236) • The 1986 tax reform law closed tax loopholes
opened in 1981, and reduced the individual
• The main source of revenue for the federal govern- income tax code to two brackets, making it more
ment is the individual income tax. proportional.
• Indexing is used to change the marginal tax rates to
• The Budget Deficit Reduction Act of 1993 added
offset the effects of inflation. two marginal tax brackets, restoring the progressive
• The second largest revenue source is the FICA tax, nature of the tax removed in 1986.
collected to cover Social Security and medicare.
• The Taxpayer Relief Act of 1997 provided the
• The corporate income tax is the third largest source wealthy with long-term investment tax breaks, and
of federal revenue. provided modest tax relief for individuals with child
and educational expenses.
• Other sources of federal revenue include excise

taxes, gift taxes, customs duties, and user fees, Flat tax proposals can be mildly progressive, but in
which is a different name for a benefit tax. general reject the ability-to-pay principle of taxation.

11. tax on the transfer of property when a person dies
12. tax paid by those who can most afford to pay
13. third largest source of income for the federal
Self-Check Quiz Visit the Economics: Principles
and Practices Web site at epp.glencoe.com and
click on Chapter 9”Self-Check Quizzes to prepare

Reviewing the Facts
for the chapter test.

Section 1 (pages 223“229)
Identifying Key Terms 1. Describe how taxes can be used to affect people™s
On a separate sheet of paper, choose the letter of the term
2. Illustrate, using supply and demand curves, how
identified by each phrase below.
the burden of a tax can be shifted.
a. ability-to-pay h. progressive tax
3. Explain the three criteria used to evaluate taxes.
b. corporate income tax i. proportional tax
c. estate tax j. regressive tax 4. Name the two principles of taxation.
d. excise tax k. sales tax
e. FICA l. sin tax
Section 2 (pages 231“236)
f. indexing m. VAT
g. individual income 5. Describe the main features of the individual
tax principle income tax.
6. Identify the two components of FICA.
1. annual adjustment of tax brackets to keep pace
with inflation 7. Describe the corporate income tax.
8. Distinguish between excise taxes, estate and gift
2. average tax per dollar decreases as taxable income
taxes, and customs duties.
3. average tax per dollar increases as taxable income
Section 3 (pages 238“242)
9. Identify the main sources of revenue for state
4. average tax per dollar unchanged as taxable
income rises
10. List the main sources of revenue for local
5. designed to discourage consumption of socially
undesirable goods or services
11. Identify the main types of taxes that are normally
6. tax on the manufacture or sale of certain items
withheld from a worker™s paycheck.
7. largest source of revenue for the federal government
8. large source of revenue for state governments Section 4 (pages 244“250)
9. national sales tax on value added at each stage of 12. Describe the four major tax reform bills enacted
production since 1980.
10. Social Security and medicare taxes 13. List the advantages and disadvantages of a VAT.

14. Identify the income group that will receive the he owe in federal income taxes? What did he pay
most benefit under a flat tax. in Social Security taxes? What did he pay in
medicare taxes?
15. Explain why future tax reforms are inevitable.

Thinking Like an Economist
Thinking Critically
Describe how an economist might go about analyz-
1. Synthesizing Information If you were an elected
ing the consequences of shifting from the individual
official who wanted to increase tax revenues,
income tax to a consumption tax like the VAT.
which of the following taxes would you prefer to
use: individual income, sales, property, corporate
Technology Skill
income, user fees, VAT, or flat? Provide reasons
for your decision.
Using a Database For one week, keep a journal of
2. Making Comparisons Distinguish between the
all taxes you hear about on television or read about
benefit and the ability-to-pay principles of taxa-
in the newspaper. Classify your journal entries into
tion. Use a web like the one below to help you
three categories: Federal, State, and Local taxes.
organize your answer.
Create a database that has a record for each of the
articles you used to find your information. Each
Principles of taxation
record should have a separate field for the following:
Title; Author; Year of publication; Tax category
(Federal, State, Local); Criteria of taxation (equity,
Ability to pay Benefit
simplicity, efficiency).
Using your computer™s software, sort the records by
Applying Economic Concepts tax category (Federal, State, Local). Create a hard
copy of this report. Share your database with the rest
1. User Fees In your own words, prepare the ration- of the class.
ale for a user fee that you think should be enacted.
2. Sales Taxes Some people object to state and
local governments imposing sales and property
taxes. What would you say to these people in Classifying Information Make a list of five
taxes, charges, or user fees that you pay in
defense of the two taxes?
your community. Draw a matrix like the one
3. Flat Taxes Evaluate the concept of a flat income below and classify each of your five taxes in
tax using the three criteria for effective taxes. the appropriate place.
Write a brief summary of your support or opposi-
Ability-to-Pay Benefit
tion to such a proposal.
Principle Principle
Math Practice Proportional
After deductions and exemptions, Mindy™s unmar- Progressive
ried brother had taxable income of $87,000 in 1999.
According to the tax table in Figure 9.5, what will
Practice and assess key social studies skills with
the Glencoe Skillbuilder Interactive Workbook,
Level 2.

Government expenditures are used
to maintain transportation systems
and protect the environment.

If you borrow money
because you spend
more than you earn, you run a
deficit. In Chapter 10, you will
learn how federal deficits and
surpluses impact the U.S.
economy. To learn more about
government spending, view the
Chapter 16 video lesson:
Government Spending

Chapter Overview Visit the Economics: Principles
and Practices Web site at epp.glencoe.com and
click on Chapter 10”Chapter Overview to preview
chapter information.
The Economics of
Government Spending
Main Idea Key Terms
The role of the federal government has grown, per capita, public sector, private sector, transfer
making it a vital player in the economy. payment, grant-in-aid, distribution of income
Reading Strategy Objectives
Graphic Organizer As you read the section, complete After studying this section, you will be able to:
a graphic organizer similar to this one by listing rea- 1. Explain why and how government expenditures
sons for the increase in government spending since have grown since the 1940s.
the 1940s. 2. Describe two kinds of government expenditures.
3. Describe how government spending impacts the
Rise in
Applying Economic Concepts
spending Transfer Payments Read to find out how transfer
payments serve as one of the tools used to promote
the goal of economic security.

overnment is big business in America. In
Cover Stor y fact, all levels of government in the United
States spend more than all privately owned
TVA Has Withstood a Serie
businesses combined. Government is a major player
in our economy due to its enormous expenditures.
of Attacks
The Tennessee Valley
Government Spending in
Authority [TVA] is goin
through another chang-
ing federal relationshi
with Congress that In 1999, total expenditures by federal, state,
similar to the late 1950s. TVA workers in so and local governments collectively amounted
In both periods, for- Tennessee to nearly $2.7 trillion. On a per capita, or per person,
profit power companies back
er Congress in cutting basis, this amounts to almost $10,000 for every man,
d a great influence ov
e TVA. . . . woman, and child in the United States.
on federal funding to th is
began October 1, TVA Spending in the public sector”the part of the
This fiscal year, which non-
l funds to manage core
getting no more federa economy made up of federal, state, and local govern-
d to TVA. . . . TVA is ge
power programs assigne ments”did not begin to rise significantly until the
ss from regions with
by members of Congre
battered 1940s. Several reasons account for this increase. The
For-profit power com-
rates higher than TVA™s.
power first was the huge amount of spending required
members that TVA ha
have convinced these
panies l
past and present federa because of World War II. The second reason was the
r power rates because of
lowe ....
es there are any subsidies change in public opinion that gave government a
bsidies, while TVA deni
larger role in everyday economic affairs. After the
nel, October 4, 1998
”Knoxville News-Senti

Figure 10.1

Total Government Expenditures Per Capita, Adjusted for Inflation
As a percentage of 1940

1945 Per capita
600% spending nearly quadrupled 1990s Lower rate of
during World War II. spending by the federal
government contributes to overall
400% slowdown in spending.
1940 1950 1960 1970 1980 1990 2000
Source: Bureau of Economic Analysis and the Department of the Census, various forms

Using Graphs Total expenditures at all levels of government have
increased significantly over time. Even when adjusted for inflation, per
capita expenditures have increased by nearly 800 percent since 1940. Visit epp.glencoe.com and click on
Does the graph show any extended period of decreased Textbook Updates”Chapter 10 for
government spending? an update of the data.

Great Depression, government was called upon to Two Kinds of Spending
regulate banks, public utilities, and many other
In general, government makes two broad
kinds of expenditures. The first is the pur-
A third reason was the success of large-scale
chase of goods and services. As Figure 10.2 shows,
public works projects like the TVA, which brought
all levels of government combined consume nearly
low-cost electricity to millions in the rural South dur-
one-third of the nation™s output. The second is in
ing the mid-1930s. The events of the 1930s and early
the form of payments to disadvantaged Americans
1940s set the stage for the unprecedented growth of
and other designated groups.
government spending shown in Figure 10.1.
Over time, many Americans have accepted
increased government expenditures as the inevitable
Goods and Services
consequence of progress. Still, some people question
how many goods and services government should The government buys many goods, such as
provide”and, therefore, the level of revenue collec- tanks, planes, ships, and even space shuttles. It
tion required to support these expenditures. needs office buildings, land for parks, and capital
Others question what services the government goods for schools and laboratories. The govern-
should provide and what services the private ment also needs to purchase supplies and hire peo-
sector”the part of the economy made up of private ple to work in its agencies and staff the military.
individuals and privately-owned businesses”should Payments for these services include the wages and
provide. salaries paid to these workers.

The government uses goods, services, and other aid for people with disabilities. People normally
resources to provide the public goods and services receive these payments solely because they need
that most Americans enjoy. In general, the more assistance.
the government provides, the more goods and There are different kinds of transfer payments.
services it consumes in the first place. A transfer payment one level of government
makes to another is known as a grant-in-aid.
Interstate highway construction programs are
Transfer Payments an example. The federal government grants
money to cover the major part of the cost, while
The second kind of government expenditure is
the states in which the highways will
a transfer payment”a payment for which the gov-
be built pay the rest. The construction of new
ernment receives neither goods nor services in return.
public schools also can be financed through
Transfer payments to individuals include Social
Security, welfare, unemployment compensation, and

Figure 10.2

Government Spending as a Percent of Total Output, 2000
Total Government
Spending in the U.S.
Spending From
Federal Grants to
State and Local
Total State and State and Local
Local Spending Governments
12% 3%

Private Government
71% 29%

Total Federal
Spending for Direct
Federal Programs

Source: A Citizen™s Guide to the Federal Budget, FY 2000

Using Graphs The circle graph shows that all levels of government
combined account for about 29 percent”nearly one-third”of the
nation™s total output. The bar graph shows that federal spending
accounts for two-thirds of all government spending, or 20 percent of Visit epp.glencoe.com and click on
the total output. Do state and local governments derive most of Textbook Updates”Chapter 10 for
their monies for expenditures from revenues or from federal an update of the data.

Impact of Government Spending decision to buy fighter planes from one factory
rather than from another has an impact on the
The enormous size of the public sector communities near both factories. Many businesses
gives it the potential to affect people™s daily not linked to either company will feel the effects
lives in many ways. Several of these effects are when workers are laid off or get new jobs and alter
examined below. their spending habits. These situations are not
merely hypothetical. The military base closings of
Affecting Resource Allocation the 1990s had a devastating impact on incomes in
local communities that had come to depend on the
Government spending decisions directly affect
military installations.
how resources are allocated. If the government
On the positive side, government can provide
spends its revenues on projects such as missile sys-
temporary income support for selective groups. In
tems in rural areas rather than on social welfare
1999, for example, the Department of Agriculture
programs in urban areas, economic activity is stim-
purchased millions of pounds of pork in an
ulated in rural areas as resources are shifted there.
attempt to support low pork prices for farmers.
The allocation of resources can be affected indi-
rectly as well. In agriculture, the decision to sup-
port the prices of milk, grains, or peanuts keeps the Competing With the Private Sector
factors of production working in those industries.
When the government produces goods and
services, it often competes with the private sector. In
Redistributing Income the area of higher education, many public colleges
Government spending also influences the and universities compete with more expensive pri-
distribution of income, or the way in which income vate ones. In many cases the cost difference is due to
is allocated among families, individuals, or other the subsidies received by the public institutions.
designated groups in the economy. The incomes of In the area of health care, the government runs
needy families, for example, can be directly affected a system of hospitals for military veterans. Taxpayer
by increasing or decreasing transfer payments. dollars fund these facilities, which compete with
Incomes are affected indirectly when the gov- hospitals in the private sector that offer similar
ernment decides where to make expenditures. The services.

Checking for Understanding Applying Economic Concepts
1. Main Idea Using your notes from the graphic 6. Transfer Payments Do you think that transfer
organizer activity on page 255, describe why payments, such as unemployment compensa-
government spending during the Depression tion, are a successful or unsuccessful way to
increased. accomplish the goal of economic security?
Defend your answer.
2. Key Terms Define per capita, public sector,
private sector, transfer payment, grant-in-aid,
distribution of income.
3. Describe the per capita growth in govern-
7. Making Generalizations Is government
ment spending since 1940.
spending too much? Interview five people
4. List two kinds of government spending. to learn their views on this question.
Summarize their views in a short paper.
5. Identify three ways that government spend-
ing may impact the economy. Practice and assess key social studies skills with
the Glencoe Skillbuilder Interactive Workbook,
Level 2.

Using E-Mail
Electronic mail, or E-mail, refers to communicating at a distance through the
use of a computer. A computer is ready to “talk” to other computers after
two things are added to it: (a) a modem”or device that allows communica-
tion through a telephone line, and (b) communications software, which lets
your computer prepare and send information to the modem.

After you type in your
message, you may send it,
forward it, and even save
it to a folder.

Learning the Skill Practicing the Skill
To send an E-mail message, complete the Select a current issue in economics to research.
following steps: Possible topics include, What is the effect of the debt on
the ecomony? and, What steps can be taken to reduce the
• Select the “Message” function from your commu- debt? Then browse the Internet to obtain the E-mail
nications software.
address of a federal official concerned with the issue.
• Type in your message, and proofread it for errors. E-mail the official, sharing opinions about the issue,
asking questions about the issue, and requesting
• Type in the E-mail address of the recipient and information.
select the “Send” button.
The E-mail system places the message in the
receiver™s electronic mailbox. He or she may read the
message at any time, and send you a return message.
When you receive E-mail, the sender™s address is on E-mail a classmate. Forward the information you
the message”add it to your electronic address book received from the government official concerning
at that time. the issue above. Working together, write a summary
of the E-mail correspondence with the official.
Federal Government Expenditures
Main Idea Key Terms
The federal government™s budget supplies money for federal budget, mandatory spending, discretionary
many services and programs. spending, fiscal year, federal budget surplus, federal
budget deficit, appropriations bill, medicaid
Reading Strategy
Graphic Organizer As you read the section, complete
a graphic organizer similar to the one below that After studying this section, you will be able to:
describes the different types of government spending. 1. Explain how the federal budget is established.
2. Describe the parts of the federal budget.
Applying Economic Concepts
Mandatory Spending Remember those FICA taxes
deducted from your paycheck? The government does
not save your FICA taxes until you retire. As soon as
Mandatory Discretionary
this money is collected from you, the government
spends it as Social Security payments to others, which
is why they are called transfer payments.

aking action on spending bills is but one step
Cover Stor y in the preparation of the federal budget”an
annual plan outlining proposed revenues
Disunity on and expenditures for the coming year.
Spending Bill Approximately two-thirds of the federal budget
consists of mandatory spending”spending author-
Washington”Pleading ized by law that continues without the need for
e U.S.
unity, Speaker [of th annual approvals of Congress. Mandatory spending
tives] J.
House of Representa includes interest payments on borrowed money,
Dennis Hastert told Social Security, and Medicare. The remaining one-
at they
Republicans Tuesday th
third of the budget deals with discretionary
d pass
must stick together an
spending”programs that must receive annual
or risk
the party™s major bills
in the authorization. Discretionary spending decisions
losing their majority
Speaker Hastert
addresses Congress include how much to spend on programs such as
of mutual respect the military, the Coast Guard, and welfare.
despite a public display
rt™s pep talk, they are
Republicans after Haste
to pass . . . spending
eply divided over how
still de
Establishing the Federal Budget
bills to finance the Gov
blican, reminded the
tert, an Illinois Repu
223“211 majority and The federal budget is prepared for a fiscal
icans of their precarious
e House next year if year”a 12-month financial planning
that they could lose th
slature, govern them-
d not govern the legi period that may or may not coincide with the
they di
bills”the only thing
and pass the spending calendar year. The government™s fiscal year starts
ired to do.
Congress is legally requ on October 1 of every calendar year and expires
June 9, 1999
”The New York Times, on September 30 of the following year.

Executive Formulation
The first step in the process of developing the
Using Technology
budget is executive formulation. This means that
In an attempt to improve performance and
the president establishes the general budget guide-
reduce bureaucratic costs, the Social Security
lines for a multiyear period, with the primary
Administration is modernizing its computer
focus on the upcoming fiscal year.
system. Electronic “kiosks,” with touch-
As part of the preparation, the president con-
sensitive TV monitors, are being constructed in
fers with government agencies, other executive
malls and public buildings. The kiosks are
office units, and the Office of Management and
designed to be a user-friendly place where
Budget (OMB), the division of the executive
people can apply for Social Security cards or
branch primarily responsible for assembling the
administration benefits. One kiosk in Arizona
budget under presidential guidelines. is programmed to speak the Navajo language.
By law, the federal budget must be sent to These kiosks will be connected to Social
Congress no later than early February. However, Security computers so that people can access
the budget pictured in Figure 10.3 was presented to their own accounts.
Congress in January 1999. The budget lists
$1,883.0 billion of revenues and $1,765.7 billion of
mandatory and discretionary spending. The budget
also shows a federal budget surplus”an excess of spend money for specific purposes. House sub-
revenues over expenditures”of $117.3 billion. If committees hold hearings on each bill and debate
the budget had shown expenditures to be larger the measure. If the bill is approved, it is sent to
than revenues, then it would have been a federal the full House Appropriations Committee. If it
budget deficit equal to the shortfall. Whether these passes there, the bill is sent to the entire House for
numbers turn out to be accurate depends on a approval.
number of factors, including the health of the The deadline for completing this part of the
economy and, more importantly, the will of process is September 15. However, individual
Congress. appropriations bills are often delayed, or changed in
a way that makes them incompatible with the over-
all budget targets. This is why Speaker Hastert
Action by the House expressed concern (see the cover story on page 260).
The president™s budget is only a request to By early June of 1999, the House had passed only
Congress. Congress has the power to approve, one of the 13 appropriation bills.
modify, or disapprove the president™s proposed
budget”the most difficult and time-consuming
Action by the Senate
part of the budget process. However, the House
does not debate all budget expenditures, only the The Senate receives the budget after the House
discretionary spending, which amounted to approves it. The Senate may approve the bill as
approximately $538 billion in that year. sent by the House, or it may draft its own version.
First, the House sets initial budget targets for dis- If differences exist between the House and the
cretionary spending. For example, the House might Senate versions, a joint House-Senate conference
decide that the projected expenditures for agricul- committee tries to work out a compromise bill.
ture are too high and spending on international During this process, the House and the Senate
affairs is too low, and then set different targets. often seek advice from several government bureaus
Once the budget targets are set, the House and offices, including the Congressional Budget
assigns appropriations bills to various House sub- Office (CBO). The CBO is a congressional agency
committees”effectively breaking the entire budget that evaluates the impact of legislation and projects
down into 13 smaller ones. An appropriations bill future revenues and expenditures that will result
is an act of Congress that allows federal agencies to from the legislation.

Final Approval the president would agree to continue to operate at
the previous year™s spending levels.
If everything goes as planned, the House and the
Once signed by the president, the budget
Senate approve the compromise bill and then send
becomes the official document for the next fiscal
it to the president for signature. Because Congress
year that starts on October 1 and ends on
literally took apart, rewrote, and put back together
September 30. The budget shown in Figure 10.3 is
the president™s budget, the final version may or
called the fiscal year 2000 budget because nine of
may not resemble the original proposal.
the 12 calendar months fall in that year.
If the budget was altered too much, the presi-
dent can veto the bill and force Congress to come
up with a budget closer to the president™s original
Major Spending Categories
version. Or, if Congress fails to pass a budget in
The thousands of individual expenditures in
time for approval by the Senate, the government
the federal budget can be grouped into the
can shut down briefly”as it did in late 1995 and early
broad categories shown in Figures 10.3 and 10.4.
1996. However, it is more likely that Congress and

Figure 10.3

The Federal Budget for Fiscal Year 2000
Expenditures $1,765.7 billion
Revenues $1,883.0 billion
Surplus $117.3 billion
Social Security 23.1%
Individual Income Tax 47.8%
National Defense 15.5%
Income Security 14.6%
Medicare 12.3%
Interest on Debt 12.2%
Health 8.6%
Social Insurance & Contributions 33.8%
Education, Training & Social Services 3.6%
Transportation 2.6%
Veterans™ Benefits 2.5%
Corporate Income Tax 10.1%
Administration of Justice 1.6%
Excise Taxes 3.7%
Natural Resources & the Environment 1.3%
Estate and Gift Taxes 1.4%
General Science, Space & Technology 1.1%
Customs Duties 1.0%
Other* 3.4%
Miscellaneous 2.2%
Source: Economic Report of the President, 1999
*Other includes Agriculture, International Affairs, General Government, Community and Regional Development,
Commerce and Housing Credit, and Energy.

Using Graphs The federal budget for fiscal year 2000 projected
revenues of nearly $1.9 trillion and expenditures of more than $1.7
trillion. From what source does the federal government receive
Visit epp.glencoe.com and click on
nearly half of its revenues?
Textbook Updates”Chapter 10 for
an update of the data.

Figure 10.4

Federal Government Expenditures, 1980“2000

23.2% 23.1%

20.6% 19.8%


12.3% Medicare
9.1 % 11.7%

Net Interest
5.6% 12.2% on Debt
Education, Training,
4.0% Employment & Social Services
3.7% Transportation
2.4% 3.6%
3.7% Veterans™ Benefits
2.3% 2.6%
1.2% General Science,
1.9% 2.5%
1.0% Space & Technology
0.9% International Affairs
6.9% 3.0% Other

1980 1990 2000
Source: Economic Report of the President, various years

Using Graphs The major categories of federal government
expenditures show some change from 1980 to 2000. The three largest
Visit epp.glencoe.com and click on
federal spending categories in 2000 were Social Security, national
Textbook Updates”Chapter 10 for
defense, and income security. How has spending for Social Security
an update of the data.
changed during the period from 1980 to 2000?

Payments to aged and disabled Americans programs, and retirement benefits for the military.
through the Social Security program make up the Subsidized housing, child nutrition, and food pro-
largest category of federal spending. Retired grams for low-income families also fall under this
persons receive benefits from the Old-Age and category. Most of these expenditures are manda-
Survivors Insurance (OASI) program. Those tory, and are therefore not authorized annually.
unable to work receive payments from disability Medicare, a health-care program available to all
insurance (DI) programs. senior citizens regardless of income, began in 1966.
Because Social Security is one of the mandatory The program provides an insurance plan that cov-
spending categories, Congress simply takes the ers major hospital costs. It also offers optional
amount to be spent as a given that is dependent on insurance that provides additional coverage for
the number of people eligible for Social Security doctor and laboratory fees, outpatient services, and
payments. some equipment costs. This is another of the
For much of the late 1900s, national defense mandatory programs that does not require annual
comprised the largest category of spending, funding approval.
although it is now second to Social Security.
National defense includes military spending by the
Department of Defense and defense-related atomic
energy activities, such as the development of
nuclear weapons and the disposal of nuclear
wastes. This is the largest single discretionary cate-
Student Web Activity Visit the Economics: Principles
gory whose spending is approved annually. and Practices Web site at epp.glencoe.com and click
Income security includes expenditures for retire- on Chapter 10”Student Web Activities for an activ-
ment benefits to railroad workers and disabled coal ity on the federal budget.
miners, civil service retirement and disability

60% France
Percent of GDP
Spending as a

40% United Kingdom
Our government certainly spends a lot of money, Japan
30% United States
but other nations spend even more. A compari-
son of the total government spending as a per-
centage of total output, or Gross Domestic
™89 ™91 ™93 ™95 1997
Product, is shown in the graph.
Source: A Citizen™s Guide to the
Using this method, we can get a general Federal Budget, FY 2000
impression of the size of the economic role of dif-
ferent governments. France and Italy are among Critical Thinking
the biggest spenders”with total government
outlays exceeding 50 percent of their GDP. 1. Analyzing Information Which nations™
Germany and Canada are not far behind. During expenditures stayed at a level between 30
and 40 percent of their GDP?
the time period shown on the graph, Japan and
the United States generally spent between 30 and 2. Drawing Conclusions Would you agree
40 percent. with the statement that government
spending by the United States “follows a
consistent trend?” Why or why not?

When the federal government spends more than Federal Expenditures
it collects in taxes and other revenues, it borrows
money to make up the difference. Interest on the
federal debt made up the third largest category of
federal spending for fiscal year 2000. The amount
of interest paid varies with changes in interest rates
and is a mandatory expenditure.
Health-care services for low-income people, dis-
ease prevention, and consumer safety account for
this part of the federal budget. One popular pro-
gram in this category is medicaid, a joint federal-
state medical insurance program for low-income
persons. Another is the Occupational Safety and
Health Administration (OSHA)”a federal agency
that monitors occupational safety and health in the
workplace. Still others include AIDS and breast
cancer research, substance abuse treatment, and
mental health service programs. Some programs
such as medicaid are part of mandatory expendi-
tures, although many others are considered to be
Other broad categories of the federal budget Natural Resources Biologists and conservation
specialists release a farm-raised alligator into
include education, training, employment, and
wetlands. What percentage of federal expendi-
social services; transportation; veterans™ benefits;
tures went to natural resources and the
administration of justice; and natural resources and environment?
the environment.

Checking for Understanding eligibility to receive Social Security payments.
Ask about the age, other eligibility require-
1. Main Idea Using your notes from the graphic
ments, and the amount of the Social Security
organizer activity on page 260, write a defini-
tion of mandatory spending.
2. Key Terms Define federal budget, mandatory
spending, discretionary spending, fiscal year,
federal budget surplus, federal budget deficit,
6. Understanding Cause and Effect People are
appropriations bill, medicaid.
living longer, and families have fewer mem-
3. Describe the three stages required to estab- bers. How will the combination of these
lish the federal budget. two factors affect transfer payments, such
as Social Security, in the future?
4. List the five largest components of federal
government spending. 7. Finding the Main Idea When the federal
government spends more than it collects,
Applying Economic Concepts
how does it make up the difference?
5. Mandatory Spending Contact your local Social
Security office to find out about a person™s Practice and assess key social studies skills with
the Glencoe Skillbuilder Interactive Workbook,
Level 2.

A New Economics:
John Maynard

John Maynard Keynes is widely
regarded as the most influential
economist of the twentieth cen-
Bank of England. He was
tury. He wrote numerous books
instrumental in the plan-
and articles that focused on short-
ning of the World Bank. For
run problems, instead of the long-
his service to Great Britain,
run equilibrium solutions
Keynes was knighted in 1942.
prevalent at the time. Keynes
defended his short-run approach
on the grounds that “in the long insight into the workings of a
run, we are all dead.” depression-era economy. Soon, the
Keynes™s General Theory divided
His most famous and influen- label Keynesian economics stood for
the economy into four sectors”
tial work is The General Theory of any spending and taxing policies
consumer, investment, govern-
Employment, Interest, and Money designed to stimulate the private
ment, and foreign. Keynes argued
(1936). The book, written during sector.
that the health of the economy is
the depths of the Great Depression, The influence of Keynes was
based on the total spending of all
offered new insights in the midst such that it led, in part, to the
the sectors. He hypothesized that a
of a crisis. The policy recommen- development of our national
fall in spending by the business
dations derived from his theories income and products accounts
sector could have a magnified
soon took the world by storm. (NIPA) that are used to measure
impact on other sectors of the
GDP and NNP.
economy. Increased government
E C O N O M I S T, T E A C H E R
spending could offset this process.
These ideas stood in stark opposi-
Keynes attended Eton, and then
Examining the Profile
tion to classical economics, which
Cambridge University. After gradu-
emphasize laissez-faire policies.
ation, Keynes returned to 1. Synthesizing Information Write a
They have been dubbed the New
Cambridge as a lecturer. In addi- brief description of Keynesian econom-
Economics, or, more frequently,
tion he served, at various times, as ics and compare it with one of classical
Keynesian economics.
editor of the famous Economic economics to explain why the former
The theories were revolutionary
Journal, on the staff of the was labeled “the New Economics.”
and they provided much needed
Treasury, and as a director of the 2. For Further Research Find out in
what ways countries today follow
Keynesian economic policies.

State and Local Government
Main Idea Key Terms
Like the federal government, state and local govern- balanced budget amendment, intergovernmental
ments have budgets that provide money for many expenditures
programs and services.
Reading Strategy After studying this section, you will be able to:
Graphic Organizer As you read the section, complete 1. Explain how state and local governments approve
a graphic organizer similar to the one below by listing spending.
and describing the components of the categories that 2. Identify the major categories of state government
account for more than 10 percent of local spending. expenditures.
3. Identify the major categories of local government
10% or more
Applying Economic Concepts
Human Capital is one of the most important invest-
ments we can make. Read to find out how state and
local governments support this investment.

tate and local levels of government, like the
Cover Stor y federal government, also have expenditures.
Like the federal government, these govern-
State Government Nears ments must approve spending before revenue dollars
can be released. As the cover story shows, the budget
Breakdown process at the state and local levels can be just as
complicated as it is at the federal level.
The budget war went
nuclear this week
Concord (N.H.) parti
Approving Spending
larly between [Governo
Jeanne Shaheen and Hou Approving spending at the state level can take
Speaker Donna Sytek. New Hampshire politics many forms. In most states, however, the
ly 1 dead-
With the Ju not so picture-perfect process is loosely modeled after that of the federal
fiscal year
line for a new king
House nor the Senate ta government.
nearing and neither the state
became more apparent Some states have enacted a balanced budget
action on the budget, it ntinu-
for a shutdown or a co amendment”a constitutional amendment that
government is heading ar™s
going at the current ye requires that annual spending not exceed rev-
ing resolution to keep to be
rtisan politics appears
spending level. . . . [P]a enues. Under these conditions, states are forced
down. . . . It all is one
driving the budget show to cut spending when state revenues drop. A
is going to need some
complicated mess that reduction in revenues may occur if sales taxes or
d any time soon. . . .
heads if it is to be resolve state income taxes fall because of a decline in the
t, June 13, 1999
”Foster™s Daily Democra general level of economic activity.

At the local level, power to approve spending The largest category of state spending is
often rests with the mayor, the city council, the intergovernmental expenditures”funds that one
county judge, or some other elected representative level of government transfers to another level for
or body. Generally, the amount of revenues col- spending. These funds come from state revenue
lected from property taxes and other local sources sources such as sales taxes, and they are distributed
limits the spending of local agencies. If state and to towns and other local communities to cover a
local governments are unable to raise the revenue variety of educational and municipal expenditures.
they need, they must deal with having inadequate The second largest category of state expenditures
resources to hire teachers, police officers, or other is public welfare. These payments take the form of
state and local workers. cash assistance, payments for medical care, spend-
ing to maintain welfare institutions, and other
miscellaneous welfare expenditures.
State Government Expenditures Many states have their own retirement funds
and insurance funds for state employees. Money
The major types of state government in these funds is invested until such time as peo-
expenditures are shown in Figure 10.5. ple retire, become unemployed, or are injured on
Seven of the most important categories, account- the job. Contributions to these funds make this
ing for nearly 80 percent of all state spending, are category the third largest type of spending overall.
examined next. Generally a large category, higher education is a
traditional responsibility of state governments with
their networks of state colleges and universities.
Local governments spend less in this area, usually
to support community colleges and universities.
Highway construction and road improvement
expenditures represent a significant portion of
Budget Analyst
state expenditures. The federal government builds
and maintains much of the interstate highway sys-
Are you good at analyzing


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