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Chapter 7 Market System Participants 
I. Households Earn and Spend
II.  Business Population is Varied
III. Governments Tax and Spend
IV. Taxation Philosophies
V. Tax Rate Types
VI. Federal Tax Changes
VII. Are Taxes Fair
I. Households Earn and Spend

       A. Income is earned for land, labor,
        capital and enterprise. 
B. Capital and enterprise changed the
         labor's profile




2000 Functional Distribution of Income 
(in billions of dollars)

  2000 2006

Wages and Salaries
$5,639 70.3% 7,448.3 69.9%

Corporate Profit
960 12.0% 1,553.7 14.6%

Proprietors' Income
711 8.9% 1,006.7 9.4%

568 7.1% 598.5 5.6%

140 1.7% 54.5 0.5%

Data take from Gross Domestic Product
 of the Bureau of Economic Analysis and
Census Bureau.

    C. What Was Done 2006 Income

Analysis: One of the weaknesses of National Income Accounting, covered in the next chapter, is it doesn't measure everything. Here, we see negative saving because expenditures from the underground economy have been included but income has not been included as people illegally avoid taxes. Also, expenditures on home improvements count, but gains when the home is sold are not personal income but capital gains. SS and Medicare tax rates go up continually and aren't help when people get older and aren't savings.

  billions of $ % of PI
Personal Income 10,983.4 100.0%
Personal Taxes 1,354.3 12.3%
Disposal PI 9,629.1 87.7%
Consumption 9,590.3 87.3
Savings 38.8 0.4

Data take from GDP  of the Bureau of Economic Analysis

II.  Business Population
     is Varied

       A. Businesses types 
         1.  Manufacturers
         2.  Wholesalers
         3. Retailers
         4. Services.
     B. Legal forms of business ownership

Legal Form


Ease of Formation

Length of Life

Raising Capital 

Owner's Liability



One Owner




Unlimited, personal assets at risk

Once as personal income


Two or More Owners




Unlimited, personal assets at risk

Once as personal  income


Company is a legal entity

Somewhat Difficult



Limited to investment

Twice as income & dividends

III. Governments Tax and Spend
A. Why federal government spending has grown
            1. Population growth
            2. War and defense requirements
            3. Urbanization
            4. Environmental concerns
            5. Inflation
            6. Transfer payments
                a. Social Security
                b. Medicare and Medicaid
                c. Social programs for the needy such as Aid to Families
                    with Dependent Children
                d. Mid-1960's social programs were  3% of national output,
                   today they are 12% of output
            7. Terrorism  
                 B. Federal Government Spending
            1. Income security
            2. Defense (military preparedness)
            3. Interest on public debt
            4 . Discretionary programs

                 C. Federal Government Receipts
              1. Personal income taxes
                a. Marginal rate is the rate paid on additional or incremental income.
                   1 Mathematically it is the increase in taxes paid divided by the
                      increase in income. 
                   2 With a progressive tax system, each higher tax bracket
                      (grouping) has a higher rate on the income in the higher bracket. 
               b. Average tax rate is the taxes paid divided by total taxable income. 
                   1 Calculating the average tax rate and amount paid by a 2000 single   
                   2 How the recent tax cut affected the average tax rate and amount
                      paid by a single person for 2003.
                   3 The U.S. federal income tax rate peaked at 88% in 1942-43
                       Country Tax Rates. Note: The U.S. pays less than half the
                       medical costs while most industrial countries pay most of it.
             2. Payroll Taxes
                 a. social security and Medicare (both employer and employee pay)  
                 b. unemployment taxes (just employer pays)
                 c. average tax up dramatically last few decades
3. Corporate Income Taxes                            
a. Corporations also paying less taxes
b. Corporate tax dodgers/sorry state of corp. taxes
                              4. Excise Taxes are a sales tax on items such as jewelry, tobacco,
                 and liquor. Taxes on Producers ACDC Video
             5. Licenses and Fees



Calculating 2000 Tax Rates for a Single Filer

Taxable Income Marginal Rate Bracket Taxes Paid Average Rate
0 to 26,250 15 .15(26,250)  = 3,937.50 3,937/26,250 = .150
26,251 to 63,550 28 .28(63,550-26,250) =  10,444 (3,937 + 10,444) = 14,381/63,550 = .226
63,551 to 132,600 31 .31(132,600-63,550) = 21,405 (14,381+ 21,405) = 35,786/132,600 = .269
132,601 to 288,350 36 .36(288,350-132,600) = 56,070 (35,786 + 56,070) = 91856/ 288,350 = .319 
288, 351 and over 39.6    

Calculating 2003 Tax Rates for a Single Filer

Taxable Income Marginal Rate Bracket Taxes Paid Average Rate Calculation
Add previous bracket total to bracket this total and divide by bracket upper limit.
0 to 7,000 10 .1(7,000)  = 700 700/7,000 = .10 is average rate on $7,000.
7,001 to 28,400 15 .15(28,400-7,000) =  3,210 (700 + 3,210) = 3,910/28,400 = .138 is the average rate on 28,400.
28,401 to 68,800 25 .25(68,800-28,400) = 10,100 (3,910 + 10,100) = 14,010/68,800 = .204  is the average rate on 68,800.
68,801 to 143,500 28 .28(143,500-68,800) = 20,916 (14,010 + 20,916 = 34,926/143,500 = .243  is the average rate on 143,500.
143,501 to 311,950 33 .33(311,950-143,500) = 55,589 (34,926 + 55,589) = 90,515/ 311,950 = .290 is the average rate on 311,950.
311951 and over 35  

Economics AP Reviews from  

D. State and local governments
have mandatory balanced budget laws
       making the accumulation of debt difficult.   


IV. Taxation Philosophies
A. Ability to pay
             1. Those with the ability 
                 income or wealth pay more.
             2. Examples
                 a. Income tax
                 b. Sales tax
                 c. Estate taxes
         B. Benefit Received User Taxes
             1. Those deriving a benefit from 
                  government activity pay
             2. Examples
                 a. Gasoline taxes used for roads.
                 b. Social security taxes are used
                     to provide retirement and other 
                     benefits for participants.
         C. Readings  
             1. It's the Inequality Stupid 02/04/11 
                 Issue of Mother Jones

2. Taxing the rich 4/11/11, NYT 
Who pays Taxes in the USA?
                from the Big Picture

Some want higher taxes on the Wealthy.

Payroll Taxes are Very Regressive


V. Tax Rate Types
        A. Progressive
            1. Tax rate increases as income increases
            2. Tax rate decreases as income decreases
            3. Those earning higher income pay a higher average tax rate.
            4. Example: Federal Income Tax                
Moving into a higher tax bracket does not result in your paying a
                higher rate on lower bracket earnings.
            5. How progressive is U.S. Federal Tax System? A Historical, World Perspective                 by Tom Piketty and Emmanuel Saez
            6. Merely Affluent vs. Truly Rich explores the change in top bracket taxes.
                NYT, Nov 2, 2010
            7. Policy Makers Often Overstate the Marginal Tax Rate 7/22/14
        B. Proportional
            1. Tax rate as percentage stays the same.
            2. Examples: Social Security taxes are proportional up to the maximum income
                level of about $76,200 because both employer and employee pay a constant
                rate of about 8%, but then the tax is regressive as the rate drops to zero
        C. Regressive 
            1. Amount paid divided by income drops as income increases.
            2. Happens one of two ways
                a. Rate drops as income increases (FICA after about $76,200 in 2000) 
                b. Amount of tax is constant so at higher incomes, the effective tax rate
                    is lower (excise taxes on cigarettes, liquor, etc.)
         D. Passing Tax Incidence 
              1.Passing the burden of taxes onto others (consumers ultimately pay)
              2. Businesses and professionals try to do this
              3. The consumer bears most of the tax burden in a market economy
              4. Social Security and the Ghost of Ronald Reagan

Average Tax Rate from Wiki its taxes paid/ taxable income

effective  tax rates
The key word here is "effective" -- these are the tax rates people actually pay after factoring in things like the mortgage interest deduction, the child tax credit and the myriad other deductions and credits written into the U.S. tax code. Values for 2011 and 2012 aren't yet available, but the CBO does provide projections for 2013 tax filings, which I've plotted, as well.  from Washington Post  4/11/14 Editors Note: The latest data shows that the top tenth of the top 1% get most of that percentiles income! We need a Teddy Roosevelt to get us out of the second Gilded age!  Please  


          E.  "The “tax wedge”, the difference between total labor costs to the employer and employees’ take-home pay, rose by 0.2 percentage points to 35.9% in 2013. Of the 34 mostly rich countries in the OECD, 25 reported a rise in the tax burden in the past three years. The largest increase in the tax wedge was in Portugal. America’s wedge also grew as reductions in employees’ Social Security contributions expired. Overall, there has been little change in taxation for single workers, which in all OECD countries except Mexico and Chile is higher than it is for those with families. Belgium’s tax wedge remains the biggest, at 55.8%; that is more than double the figure in Mexico and New Zealand—and eight times that in Chile."


VI. Federal Tax Changes
        A. Reported by IRS in form 1040 after the Tax Rates Schedules.
        B. Income

Income Source 1999 2002 2005 2008
Personal income taxes 48%  43% 38% 39%
Social Security, Medicare, unemployment, and other retirement taxes 34% 35% 32% 38%
Corporate income taxes 10% 7% 11% 10%
Excise, customs, estate, gift, and miscellaneous taxes 8% 7% 6% 6%
Borrowing to cover deficit Surplus 8% 13% 15%
Source IRS 1040 FORMS
C. Outlays 1999 2002 2005 2008
Social security, Medicare, and other retirement 35% 38% 37% 37%
National defense in 1999 (15%) , veterans benefits and services (2%), and foreign affairs (1%) 18% 20% 24% 24%
Social programs: in 1999, 12% for Medicaid, food stamps, temporary assistance for needy families, supplemental security income  and related programs and 6% for health research and public health programs, unemployment compensation, assisted housing, and social services   17% 21% 20% 20%
Net interest on the debt 12% 8% 7% 8%
Physical, human and community development (agriculture, natural resources, environment, transportation, aid to elementary and secondary education and direct assistance to college students, job training, deposit insurance, commerce and housing credits, community development, space, energy, and general science) 9% 10% 10% 9%
Surplus to pay down debt 7% None None None
Law enforcement and general government 





Source IRS 1040 FORMS        

VII. Are Taxes Fair


Comparing Payroll Tax


Europe Limit Socialism's
Unintended Consequences




People Paying less 
income and capital gains taxes


Fiscal Cliff Avoided with partial reversal of Bush II tax cuts, 1/2/12  from WSJ


IX. Additional Reading:  
     A. Democratic Capitalism vs. Capitalistic Democracy  
     B. How Tax Rates have Changed NYT, 11/29/12 
     C. Household Income and Tax Distribution-in 2010 5/12/13 CBO
     D. Options for taxing more to reduce the deficit  12/11/13 CBO

     E. Great Recession Lowers Government Employment 9/8/13 Seeking Alpha
     F Presidents-2015 budget in pictures 3/19/14 
     G. U.S. tax rates the big picture 4/15/14
How Much Americans Really Pay in Taxes
Last Chapter  Next Chapter 
Chapter 7 Class Discussion Questions Table of Contents
Chapter 7Homework Questions Economics Internet Library
Masters of Tax Evasion Andrew Fieldhouse/EPI






A sea-change in household-deleveraging? 6/9/13



President's Proposed Discretionary Spending