The Macro Economy Today 14th Edition Bradley Schiller

80 THE ECONOMIC CHALLENGE
WHAT question). Were income transfers included, the relative size and growth of the federal
government would be larger than Figure 4.4 depicts. This is because most of the
growth in federal spending has come from increased income transfers, not purchases of
goods and services. Income transfers now account for more than half of federal spending.
web click
Information on government
expenditures and national
economic output for different
countries can be found at
www.cia.gov. Visit the “World
Factbook” link.
State and Local Growth
State and local spending on goods and services has followed a very different path from
federal expenditure. Prior to World War II, state and local governments dominated public
sector spending. During the war, however, the share of total output going to state and local
governments fell, hitting a low of 3 percent in that period (Figure 4.4).
State and local spending caught up with federal spending in the mid-1960s and has exceeded
it ever since. Today more than 80,000 state and local government entities buy
much more output than Uncle Sam and employ five times as many people. Education is
a huge expenditure at lower levels of government. Most direct state spending is on colleges;
most local spending is for elementary and secondary education. The fastest-growing
areas for state expenditure are prisons (public safety) and welfare. At the local level,
sewage and trash services are claiming an increasing share of budgets.
opportunity costs: The most
desired goods or services that
are forgone in order to obtain
something else.
TAXATION
Whatever we may think of any specific government expenditure, we must recognize one
basic fact of life: we pay for government spending. We pay not just in terms of tax dollars
but in the more fundamental form of a changed mix of output. Government expenditures
on goods and services absorb factors of production that could be used to produce consumer
goods. The mix of output changes toward more public services and fewer private goods and
services. Resources used to produce missile shields, operate elementary schools, or journey
to Mars aren’t available to produce cars, houses, or restaurant meals. In real terms, the
cost of government spending is measured by the private sector output sacrificed when
the government employs scarce factors of production.
The opportunity costs of public spending aren’t always apparent. We don’t directly
hand over factors of production to the government. Instead we give the government part of
our income in the form of taxes. Those dollars are then used to buy factors of production or
goods and services in the marketplace. Thus the primary function of taxes is to transfer
command over resources (purchasing power) from the private sector to the public sector.
Although the government also borrows dollars to finance its purchases, taxes are the
primary source of government revenues.
Federal Taxes
As recently as 1902, much of the revenue the federal government collected came from taxes
imposed on alcoholic beverages. The federal government didn’t have authority to collect
income taxes. As a consequence, total federal revenue in 1902 was only $653 million.
progressive tax: A tax system in
which tax rates rise as incomes
rise.
Income Taxes. All that changed, beginning in 1915. The Sixteenth Amendment to the U.S.
Constitution, enacted in 1915, granted the federal government authority to collect income
taxes. The government now collects well over $1 trillion in that form alone. Although the
federal government still collects taxes on alcoholic beverages, the individual income tax
has become the largest single source of government revenue (see Figure 4.5).
In theory, the federal income tax is designed to be progressive—that is, to take a larger
fraction of high incomes than of low incomes. In 2014, for example, a single person with
less than $9,000 of taxable income was taxed at 10 percent. People with incomes of
$37,000–$89,000 confronted a 25 percent tax rate on their additional income. The marginal
tax rate got as high as 39.6 percent for people earning more than $407,000 in income.
Thus people with high incomes not only pay more taxes but also pay a larger fraction of
their income in taxes.