Chapter 10

Introduction to
Government Finance
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Printed in the United States of America
ISBN 0-03-033652-X
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 Federal, State, and Local
Revenue
$2.5 trillion
 Sources:
 Taxes:
 Payroll
 Income (Corporate and Personal)
 Property
 Sales and Excise
 Estate
 Tariffs
 Fees
 Tuition
 Licenses

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 Determinants of How Much We
Are Taxed

 Political Equilibrium
 Market Equilibrium and Its Efficiency
 The Distribution of Income

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 Taxes

 Taxes are compulsory payments to

government

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 Tax Basics
 Tax Base
 The item or the activity that is to be taxed.
 Tax Rate Structure
 The relationship between the amount that is to be paid in tax and the tax base for a given accounting period.
 Marginal Tax Rate
 The amount by which the tax increases when the tax base increases.

 Average Tax Rate

 The total amount of tax divided by the total amount of the tax base.

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

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 Descriptors of the Tax Rate
Structure
 A Progressive Tax has a structure where the
marginal tax rate is increasing and greater than the
average tax rate.
 A Proportional Tax has a structure where the
marginal tax rate is constant and equal to the
average tax rate.
 A Regressive Tax has a structure where the
marginal tax rate is decreasing and less than the
average tax rate.

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 Figure 10.1 A Proportional Tax Rate Structure

Tax Rate (Percent)

ATR = MTR
t

0
Tax Base (Dollars per Year)
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 Figure 10.2 A Progressive Tax Rate Structure

MTR
35
Tax Rate (Percent)

ATR
25

15

0 4,000 29,000 70,000

Tax Base (Dollars of Taxable Income per Year)
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 Figure 10.3 An Example of a Regressive Tax
Structure

15.30
Tax Rate (Percent)

12.35

0 ATR

2.9
MTR
$76,200 $100,000
Annual Labor Earnings per Worker
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 Average Tax Rates in the US
Average Tax Rates

Tax Brackets Marginal Tax Beginning End of

(Taxable Income) Rates (MTR) of Bracket Bracket

0-$4,000 0 0 0

$4000-$29,000 15 0 11
$29,000-$70,000 25 13 20

Above $70,000 35 20 34*

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 Tax Revenues as a Percent of GDP

10
20
30
40
50
60

0
Sweden
Denmark
Finland
Belgium
France
Luxembourg

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Austria
Norway
Italy
Netherlands
Poland
Hungary
Czech Republic
United Kingdom
Germany
* Canada
Portugal
Switzerland
the World

New Zealand
Spain
* Greece
Iceland
Ireland
Turkey
* United States
Australia
Japan
Korea
Mexico
Average Tax Rates Throughout
 How Should the Burden of
Government Be Financed
 Benefit Principle
 Those that benefit the most from a
particular program should pay the most for
that program (Lindahl Tax principle at
work).
 Ability-to-Pay Principle
 Those who have the greatest ability to pay
should be required to pay the most.

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 Criteria for Evaluating Alternative
Methods of Government Finance
 Equity
 The distribution of the burden of government finance should
coincide with commonly held notions of fairness and ability-to-pay.
 Efficiency
 The system of government finance should raise revenues with only
a minimal loss in efficiency in the private sector.
 Administrative ease
 A government finance system should be relatively easy to
administer in a consistent manner without excessive costs to collect,
enforce, and comply with taxes and tax laws.

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 Tax Compliance and Evasion
 Tax Evasion is the term for illegal ways of
avoiding paying taxes. It is typically the result
of not declaring income or overstating
otherwise legal deductions.
 Tax Avoidance is the term for the legal ways
of avoiding paying taxes, typically the result
of avoiding activities that are taxed, delaying
the time in which taxes are owed, or taking an
action designed to lower a tax burden.

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 Figure 10.4 Reducing Tax Evasion
A B

Cost and Benefit

Cost and Benefit

MC MC

E
E
E 1
2

MB = MTR MB1 = MTR1

MB2
0 D* 0 D* D*
2 1
Unreported Income per Year (Dollars) Unreported Income per Year (Dollars)

C
MC2 MC
1
Cost and Benefit

E1

MB = MTR

0D* D*
2 1
Unreported Income per Year (Dollars)

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 Alternatives to Taxation
 Debt Finance is the means of financing
expenditures through the issuing of
bonds.
 Inflationary Finance is the means of
financing expenditures through the
printing of money.

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 Figure 10.5 Inflationary Finance

T
C
G2 I
Guns per Year

G1 A

0 B2 B1 T'
Butter per Year
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 More alternatives to Taxation
 Donations
 Money (but more usually time) is voluntarily given to
government. Military service or work in the Peace Corps can
be considered a donation when the compensation is less
than the market value of the time.
 User Charges
 Payments by users of the government service can be
expected. Examples include tuition, fees paid to enter state
parks, greens fees at publicly owned golf courses.
 Earmarked Taxes
 Taxes can be implemented to fund specific public goods.
Examples include gasoline taxes and tolls designed to fund
road and bridge repair.

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 Figure 10.6 User Charges and Efficiency

MSC

Z*
C* + S*
Charges

S*
C*
Z MSB = MPB + MEB
MPB

0 Q*
Trash Pickups per Year
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 Figure 10.7 User Charges for a Congestible
Government-Supplied Service
User Charges (Cents per Mile)

D1 = MSB1 D2 = MSB2 MSC

E*
20
E1 N* E2
0 80 100 120 150
Vehicles per Mile per Hour
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 Government Enterprise
 Local Utilities
 Lotteries

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 User Charges and Efficiency
 Roads and Bridges wear out when too much
weight is concentrated on too few axles.
 Tolls motivate the wrong behavior in that they
tax per axle rather than on pounds per axle.
 Estimates suggest that taxing pounds per
axle and using the revenue to repair roads to
a greater strength would pay for itself more
than eight-fold.

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 State Lotteries
 State Lotteries account for more than
3% of state revenues.
 Evidence suggests that the lottery
system is a regressive means of
creating government revenue.

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