Ohio State University Economics 4300: Government Finance

The Ohio State University Economics 4300: government Finance in the American Economy

The Ohio State University Economics 4300, Government Finance in The American Economy William J. White, Autumn 2018

Please choose the best response for the following questions. Each question is worth 2 points.

1. According to the benefit principle of taxation: a. taxes should be distributed according to peoples’ ability to pay. b. the progressive income tax represents the ideal way of distributing taxes among a nation’s citizens. c. user charges are an ideal source of finance for government-produced goods and services. d. flat-rate taxes are the only fair type, since all citizens benefit equally from provision of public goods.
2. If horizontal equity is achieved in taxation: a. individuals of equal economic capacity will pay equal taxes. b. vertical equity will also be achieved. c. a flat-tax will be used. d. the tax system will not result in losses of efficiency in markets.
3. The tax base of a payroll tax is: a. consumer expenditures. b. labor income. c. interest income. d. a combination of expenditures, labor income, and interest income.
4. What is the primary reason the United States manages to collect a high percentage of income tax assessed on its wage-earning citizens? a. The IRS audits a large percentage of tax returns and almost always catches those who attempt to evade taxes. b. Penalties for tax evasion are so severe that citizens don't attempt to cheat the IRS. c. The income tax withholding system requires employers to withhold taxes from wages and remit those payments to the government. d. The United States actually does not manage to collect a high percentage of income tax assessed on wage earners.
5. Which of the following is not necessarily an impact of persistent budget deficits? a. The tax burden is shifted from current to future taxpayers. b. Governments can accomplish current projects that have large social benefits, without raising taxes. c. The portion of the budget allocated for interest payments increases as a fraction of total spending. d. The absolute amount of government debt is increased.
6. Firms are permitted to transfer patents and trademarks to subsidiaries in other countries without charging them for the intellectual property (IP). What is the most important impact of this practice from a financial standpoint? a. Firms can reduce their US tax liability by transferring profits from high tax countries to low tax countries. b. Firms can reduce their US tax liability by transferring profits from low tax countries to high tax countries. c. Firms can reduce their US tax liability by transferring patents from low tax countries to high tax countries. d. Firms cannot benefit financially from moving IP from country to country.
7. The incidence, or true burden of a tax: a. is not dependent of the economic actor upon which the tax is imposed. b. falls most heavily on the buyer if price elasticity of demand is higher than price elasticity of supply. c. falls most heavily on the seller if price elasticity of demand is zero. d. is paid entirely by the seller if supply elasticity is infinite.
8. If government officials were most concerned about protecting consumers from higher prices, they would favor imposing taxes on goods: a. that are necessities. b. that are luxuries. c. for which the tax is likely to be forward shifted. d. for which the tax cannot be backward shifted.
9. Which of the following is true of the omnibus government funding bill passed by Congress in September 2018? a. It provides funding for all government agencies up to September 30, 2019. b. It includes the “Dream Act,” a provision that allows children brought illegally into the United States to obtain citizenship after 10 years of residency. c. It provides appropriations for less than half of the government’s cabinet departments, with the remainder funded only until a short-term CR expires on December 8th. d. It includes full funding for Donald Trump’s border wall, with construction to begin on or before January 1, 2019.
10. If government were to levy taxes only on goods and services supplied by monopolies, what would be the impact on excess burden across the economy? a. Excess burden would increase, as monopolies extracted more consumer surplus. b. Excess burden would be reduced, as monopoly excess burden is inherently lower. c. Excess burden would increase, since monopoly quantities are chosen along the MR curve, while competitive quantities are set along the demand curve. d. There would be no change in excess burden.

Essay Questions

Answer each of the following in 3-4 paragraphs. Your responses should be well-organized, with proper sentence structure, grammar, and punctuation. Focus on providing a clear and convincing narrative that addresses the question directly, avoiding bulleted lists or shorthand.

11. (15 points) What effects do government borrowing and deficit finance have on the distribution of income and well-being? In your answer discuss the intergenerational effects of deficits and the impact of deficits on saving, investment, interest rates, and economic growth.

Government borrowing and deficit financing play a significant role in shaping the distribution of income and overall economic well-being. When a government runs a budget deficit, it borrows funds to cover expenditures exceeding revenues, which can have both immediate and long-term effects. Intergenerationally, deficits often imply that current taxpayers and beneficiaries of public goods benefit at the expense of future taxpayers. Future generations are burdened with repaying debt incurred today, which may reduce their disposable income and economic opportunities. This intergenerational transfer of debt can lead to a redistribution of economic burdens and benefits downward, with potential implications for fairness and social equity (Auerbach & Kotlikoff, 1987).

In economic terms, persistent deficits tend to influence saving and investment patterns within the economy. When the government borrows heavily, it competes with private sector entities for available savings, often leading to higher interest rates—a phenomenon known as "crowding out" (Barro, 1974). Elevated interest rates can discourage private investment, which is crucial for technological innovation and productivity improvements, ultimately dampening economic growth over the long term (Levine & Renelt, 1992). Furthermore, reduced investment can lead to slower increases in capital stock, negatively affecting wage growth and income levels in the future (Blanchard & Leigh, 2013).

Moreover, reliance on deficit financing can have implications for economic stability. Fluctuations in interest rates stemming from government borrowing may lead to volatility in financial markets, potentially reducing consumer and investor confidence. Over time, persistent deficits and mounting debt can limit a nation’s fiscal flexibility, making it more challenging to respond to economic crises or fund essential public goods without resorting to further borrowing. Thus, while deficits may provide short-term stimulus, their long-term effects on income distribution, economic growth, and overall well-being could be detrimental, particularly if they undermine sustainable investment and equitable wealth distribution (Rogoff & Reinhart, 2010).

12. (15 points) Explain how our current income tax system could easily be converted into a system which taxes consumption. How would these two tax systems impact savings and investment? Discuss at least one distributional impact from this change.

The current income tax system predominantly taxes earnings from labor, capital, and other sources during the period income is received, often discouraging savings and investment due to the immediate tax burden on accumulated wealth. Transitioning to a consumption tax system involves shifting the focus from taxing income to taxing expenditures. One straightforward method would be to replace the current income taxes with a national sales tax or a value-added tax (VAT), which taxes consumption at each stage of production and sale, exempting savings from taxation. Alternatively, implementing a dual system that taxes income but allows tax-free savings could promote greater accumulation of wealth (Feldstein, 1999).

Consumption taxes tend to incentivize savings because they do not tax savings or investment initially; instead, they tax the final consumption expenditure, encouraging individuals and firms to save and invest more. Higher savings levels can lead to increased investment in capital goods, boosting productivity and economic growth over the long term (Sumner, 2014). In contrast, the current income tax system disincentivizes savings because earnings are taxed regardless of whether they are consumed or invested, which can lead to lower capital accumulation. This can result in slower economic growth and reduced future income levels (Shoven & Sial, 2002).

From a distributional perspective, switching to a consumption tax could have mixed effects. Typically, consumption taxes are considered regressive, meaning they take a larger percentage of income from lower-income households because they spend a higher proportion of their income on taxed goods and services (Veung is et al., 2014). To counteract these regressivity concerns, policymakers could include rebates or exemptions for essential goods, or implement tiered rates. Overall, replacing income taxes with consumption taxes could promote greater savings and investment, leading to higher long-term growth, but must be designed carefully to address potential adverse impacts on income distribution.

References

• Auerbach, A. J., & Kotlikoff, L. J. (1987). Dynamic fiscal policy. Cambridge University Press.
• Barro, R. J. (1974). Are government bonds net wealth? Journal of Political Economy, 82(6), 1095-1117.
• Blanchard, O., & Leigh, D. (2013). Growth forecast errors and fiscal multipliers. American Economic Review, 103(3), 114-118.
• Feldstein, M. (1999). The importance of consumption in evaluating tax reform. Journal of Economic Perspectives, 13(1), 73-94.
• Levine, R., & Renelt, D. (1992). A sensitivity analysis of cross-country growth regressions. American Economic Review, 82(4), 942-963.
• Rogoff, K., & Reinhart, C. (2010). Growth in a time of debt. American Economic Review, 100(2), 573-578.
• Shoven, J., & Sial, N. (2002). The effects of fundamental tax reform on saving, investment, and economic growth. National Bureau of Economic Research.
• Sumner, S. (2014). The economic effects of a consumption tax. Cato Journal, 34(1), 35-50.
• Veung, C., et al. (2014). Revenue-neutral carbon tax reform: Accounting for economic and distributional effects. Washington, DC: World Bank.