FACTS AND TOOLS

1. By U.S. law, your employer pays half of the payroll tax and you, the worker, pay the other half. We mentioned that according to the basics of supply and demand, the part of the tax paid by the employer is likely to cut the worker’s take-home pay. Let’s see why. We’ll start off in a land without any payroll taxes and then see how adding payroll taxes (like FICA and Medicare) affects the worker’s take-home pay.

2. It’s easy to confuse the “federal deficit” with the “federal debt.” We’ll work out an example to make the differences clear. To keep the math simple, we’ll falsely assume that in this land of Barrovia, the government can borrow from the public at an interest rate of 0%—so there is no interest on the debt. We will also assume that the government is unwilling to print money to finance its budget, so the only way to finance a deficit is by borrowing. The debt inherited from 2011 is 4,000 credits (C4,000, in the local notation). Fill in the accompanying table.

Note: The relationship between deficits and debts is similar to the relationship between investment and the capital stock, which we investigated back in Chapters 7 and 8: The first is a “flow,” while the second is a “stock”; the first is like a river, while the second is like a lake.

3. Social Security is primarily a pay-as-you-go program, which means that the government pays retirees their promised benefits by taxing today’s workers. Imagine that Social Security moved to a fully funded program in which today’s workers (or the government on their behalf) invested in assets, such as stocks and bonds, to pay for their own retirement.

4. Calculating taxes on capital gains takes a little work, but if you buy and sell stocks, bonds, works of art, or homes, you’ll probably have to do this at some point. Let’s practice. In a few of the following cases, the price will fall—just record that as a negative rise (a “capital loss,” in tax jargon). (In some cases, you can use these to offset taxes on capital gain but we won’t get into that detail here.)

5. How big is the tax break from the $3,950-per-child income tax deduction for:

7. Some people argue that a large national debt will make future generations poorer. One way to test this is to see what happened after the last time the United States had a large national debt: after World War II. As Figure 17.5 shows, the debt-to-GDP ratio was over 100%, a bit higher than even today’s ratio. Let’s compare this to Figure 6.3 and Figure 11.5, which show the growth rate of GDP and the unemployment rate, respectively.

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Note that this single case doesn’t count as conclusive proof: Perhaps the United States just got lucky, or the federal government did an unusually good job spending its World War II expenditures to build up its capital stock (a point emphasized in the excellent Francis Ford Coppola film Tucker: The Man and His Dream), or perhaps a massive short-term debt doesn’t cause much economic trouble. You can learn more about these possible explanations in other economics courses.

8. Which of the following actual government programs show up as costs in the federal budget?

The Department of Labor mandates the minimum wage for workers.

The Environmental Protection Agency mandates that cars have equipment to keep pollution levels low.

The National Oceanic and Atmospheric Administration forecasts the weather.

The Coast Guard rescues sailors from a sinking yacht off the coast of Cape Cod.

The Border Patrol requires that all vehicles driving on highways out of San Diego be stopped to inspect for the presence of illegal aliens.

1. In 1989, Senator Bob Packwood asked Congress’s Joint Committee on Taxation how much extra revenue the government would raise if it just started taxing 100% of all income over $200,000 per year. The Joint Committee crunched some numbers and reported an answer: $204 billion per year.

Note: Packwood asked the Joint Committee this question not because he wanted to raise taxes that high, but to make a point. The tale of his efforts—and the efforts of Ronald Reagan, Dan Rostenkowski, Bill Bradley, and many others—to improve the U.S. tax code in the 1980s is compellingly told in Birnbaum and Murray’s book Showdown at Gucci Gulch: Lawmakers, Lobbyists, and the Unlikely Triumph of Tax Reform.

2. Today, many government transfer programs are run through the tax code. The Earned Income Tax Credit (EITC), which we discussed in this chapter, is one important example. The federal government also has a variety of other “refundable tax credits,” that is, spending programs run through the tax code. These blur the line between “tax breaks” and “government spending.” This may explain their popularity: Voters and politicians who like tax breaks can claim that these programs are tax breaks, while voters and politicians who like higher government spending can claim that these programs are government spending.

4. Currently, the U.S. government offers “food stamps” to poor Americans. These “stamps” are pieces of paper that look like Monopoly money and can be spent just like money at many grocery stores. The government has a complex formula that determines how much each poor person gets each month in food stamps (or more often these days, government-provided debit cards).

Let’s suppose that instead, the government decides to pay 95% of every poor person’s food bill, as long as it is purchased at a typical grocery store: The poor person would make a “copayment” of 5% of the total bill, and the federal government would reimburse the grocery store for the remaining 95%. Just to keep things simple, let’s assume that the government has a good way to make sure that poor people can’t resell this food to others.

5. When discussing the statements sent to you by the federal government that predict your future Social Security payments, we said, “Don’t be surprised if those predictions turn out to be a little bit optimistic.” Consider why this might be wrong: Why might these predictions be too pessimistic, precisely because Social Security recipients are also voters? (Hint: Senior citizens are more likely to vote than younger citizens.)

!launch! WORK IT OUT

1. Suppose that Congress eliminated the tax break for homeowners. What will this law do to the demand for homes: raise, lower, or have no impact?

2. What will be the net effect of eliminating the break on the price of houses?

3. Given your answers to parts a and b, comment on who gets the benefits of the tax break. Is it people who buy homes? Sellers? (Be careful, sellers were buyers once!) Why could eliminating the tax break prove difficult?