The Federal Government uses both fiscal policy and monetary policy to influence the economy and achieve its goals of full employment, price stability, and economic growth. Fiscal policy involves taxation and government spending decisions, while monetary policy involves controlling the money supply through tools like open market operations, reserve requirements, and interest rates. Both seek to boost or slow the economy as needed through expanding or contracting the flow of money and credit. However, balancing these policies to optimize economic outcomes can be complex.

1. Chapter 16
FINANCING GOVERNMENT

2. TAXES AND OTHER REVENUE
Section 1

3. INTRODUCTION
• How is the Federal Government financed?
• The Federal Government is financed largely by direct and indirect
taxes.
• The major taxes are the individual income tax, corporation income
tax, payroll taxes, excise taxes, estate and gift taxes, and customs
duties.
• The government also raises a smaller amount of nontax revenue
through interest, fees, and sales.

4. THE POWER TO TAX
• The first power granted to Congress by the Constitution
is the power to tax.
• Congress taxes to raise revenue to operate the federal
government.
• Congress also uses the taxation power to require or
deny licenses for certain activities in order to serve the
public interest.

5. THE POWER TO TAX
• Though taxes are used to
fund the programs that the
public expects, many
complain about the burden
placed on taxpayers.
• How does this cartoon
illustrate this view?

6. DIRECT VS. INDIRECT TAXES
• A direct tax is levied upon a specific individual.
Examples include taxes on personal property or
income.
• An indirect tax can be shifted to another person for
payment. For example, a tax levied on a liquor
producer is passed along to the consumers who buy
the liquor in the form of higher prices.

7. LIMITATIONS ON TAXATION
• Congress can levy taxes only for public purposes.
• Congress cannot tax U.S. exports.
• Direct taxes on individuals must be distributed evenly
among the States.
• All indirect taxes must be set at the same rate in all
parts of the country.
• The federal government cannot tax the government
functions of State or local governments, such as
providing public education.

8. LIMITATIONS ON TAXATION
• There are exceptions to these limitations:
• The federal government can tax businesses
operated by State and local governments if they are
not considered to represent normal government
functions.
• The 16th Amendment, ratified in 1913, allows
Congress to levy a direct individual income tax.

9. INCOME TAX
• Income tax on individuals
and corporations is the
largest source of federal
revenue.
• Income taxes are
progressive—higher
earnings are taxed at a
higher rate.

10. INDIVIDUAL INCOME TAX
• Individual income tax is levied
on each person’s earnings for
the previous year, minus
certain exemptions and
deductions.
• Tax returns for the previous
year must be filed by April 15th.
The IRS receives more than
120 million returns each year.

11. INDIVIDUAL INCOME TAX
• Individual income taxes provide the bulk of federal revenue.
• Most people have income taxes withheld from their paychecks.
Others pay estimated taxes.

12. CORPORATE INCOME TAX
• Each corporation must pay income tax.
• There are many deductions allowed. For example, churches and
nonprofit or charitable organizations pay no corporate income
tax.

13. PAYROLL TAXES
• The federal government collects payroll taxes to finance Social
Security, Medicare, and the unemployment compensation
program.
• These are regressive taxes, paid at a fixed rate regardless of
income.

14. EXCISE TAXES
• Excise taxes are often figured into the retail price of goods and
services.
• Excise taxes on tobacco, alcohol, and gambling are called sin
taxes, while those on luxury goods are called luxury taxes.

15. GIFT AND ESTATE TAXES
• Gift taxes are levied on gifts from one person to another, while
estate taxes are levied on the assets of someone who dies.
• Most estates are not subject to the tax. Gifts up to $12,000 in
one year are tax-free.

16. CUSTOMS DUTIES
• Customs duties, also called tariffs or import duties, are charged
on many goods imported into the United States.
• They were once the main source of federal income, but are now
minor.

17. NON-TAX REVENUE
• The government receives interest on money borrowed
from the Federal Reserve System and other loans.
• The government also charges fees for issuing
passports, copyrights, patents, and trademarks.
• The sale or lease of public lands also generates
government income.

18. BORROWING AND THE PUBLIC DEBT
Section 2

19. INTRODUCTION
• What effect does borrowing have on the federal budget
and the nation’s economy?
• Borrowing can be used to provide an economic stimulus for
the nation and to pay off budget deficits in times of crisis or
overspending.
• However, such borrowing leads to future deficits and higher
interest payments on the increasing public debt.

20. THE POWER TO BORROW
• The Constitution gives Congress the power to borrow
money. For 150 years Congress used this power to:
• Pay for crises such as wars
• Pay for large-scale projects such as the construction of the
Panama Canal
• For most of the past 80 years, the government has
borrowed money to pay for yearly budget deficits
because it spends more than it raises from taxpayers.

21. DEFICITS AND SURPLUSES
• The government did not
have a budget surplus
from 1969 to 1998.
• The government creates
the budget based on
estimates.
• What factors mentioned
on the chart likely
affected the budget for
that year?

22. THE DEPRESSION
• At the height of the Great Depression, one fourth of the nation’s
labor force was unemployed and 18 million were dependent on
public relief programs.
• State governments, private charities, and banks were all
overwhelmed.
• The traditional approach was to keep government involvement
in the economy limited and let the free market solve the
problem.

23. KEYNESIAN ECONOMICS
• In contrast, President
Roosevelt’s New Deal used
the ideas of John Maynard
Keynes to stimulate the
economy.
• Keynes said that government
should spend heavily on public
programs during times of high
unemployment.

24. SUPPLY-SIDE ECONOMICS
• Under President Reagan, the theory of supply-side economics
took hold.
• This theory says that lowering taxes increases the supply of
money in private hands and boosts the economy without higher
government spending.
• In 2008, supply-side supporter George W. Bush approved both
an economic stimulus plan and a $700 billion bailout of home
lending institutions, both Keynesian measures for dealing with a
financial crisis.

25. BORROWING MONEY
• Congress must authorize all federal borrowing. The
Treasury Department then borrows money by selling
securities to investors.
• Securities are notes in which the government promises to
repay a certain sum, plus interest, on a certain date.
• Short term securities are usually Treasury notes, also called
T-bills.
• Long term securities are typically government bonds.

26. BORROWING MONEY
• Investors in U.S. securities
include both American and
foreign individuals, banks,
investment companies,
and other financial
institutions.
• To which group of
investors does the
government owe the
most?

27. THE PUBLIC DEBT
• The U.S. government can borrow money while offering
lower rates of interest than those charged to private
investors.
• This is because U.S. securities are seen as safe investments
and their interest is not taxed.
• Still, borrowing so much money has produced a huge
public debt for the federal government.
• This debt includes all the borrowed money not yet repaid
plus the interest owed.

28. THE PUBLIC DEBT
• The public debt has exploded over the past 30 years, passing
$1 trillion for the first time in 1981.
• About 1 in every 10 dollars spent by the U.S. government now
goes to paying interest on the public debt.

29. THE PUBLIC DEBT
• There is no constitutional limit on the public debt.
• Congress has put limits on the debt but simply raised them
when needed.
• The amount of the
debt is hard to
imagine and will
affect future
generations of
taxpayers.

30. SPENDING AND THE BUDGET
Section 3

31. INTRODUCTION
• How is federal spending determined?
• The various federal agencies submit budget proposals to the
Office of the President, which reviews and alters them before
presenting a complete budget to Congress.
• Congress makes further adjustments to the budget until
appropriations bills are approved and sent to the President
to be vetoed or signed into law.

32. SPENDING PRIORITIES
• The federal government spends
over $700 billion a year on
entitlement programs.
• These are benefits that must be
paid under federal law to people
who meet eligibility requirements.
• Social Security, Medicare,
Medicaid, and food stamps are
major examples.

33. SPENDING PRIORITIES
• The Department of Defense spent more than $636
billion on national defense in 2010.
• This figure does not include all defense-related federal
expenditures.
• Treasury Department payments on the public debt are
now the fourth-largest category of federal spending.

34. CONTROLLABLE SPENDING
• Congress and the President can decide how much to
spend on many specific items in the federal budget.
• Such controllable spending includes national parks, highway
projects, military equipment, educational aid, and civil
service pay.
• This spending is also called discretionary spending.

35. UNCONTROLLABLE SPENDING
• Many public programs have uncontrollable spending
limits that neither Congress nor the President can
change.
• This includes the interest due on the vast federal debt.
• Most entitlements—Social Security benefits, food stamps, and so
on—are also largely uncontrollable. Congress can only redefine
the eligibility standards or reduce the amount of benefits.
• Nearly 80% of all federal spending now falls into the uncontrollable
category.

36. OVERVIEW OF THE FEDERAL BUDGET
• Financially, the budget is a detailed estimate of federal income
and expenditures for the upcoming year.
• Politically, the budget is also a declaration of the President’s
public policy plans, some of which will be accepted, altered, or
rejected by Congress over a period of several months.

37. THE PRESIDENT
• At least eighteen months before a fiscal year, each federal
agency prepares detailed estimates of its spending needs for
that year.
• These plans are submitted to the President’s Office of
Management and Budget (OMB).
• The OMB reviews and adjusts these budget proposals.
• The President then sends the final budget request to Congress
on the first Monday in February.

38. CONGRESS
• The House and Senate Budget Committees study the
budget proposal with the help of the Congressional Budget
Office (CBO).
• The CBO is Congress’s independent version of the OMB.
• The Budget Committees each submit a Budget Resolution
that is debated and voted on in each house.
• The two Budget Resolutions are merged into one version
that Congress votes on by May 15th.

39. CONGRESS
• The House and Senate Appropriations Committees
use the income and spending guidelines in the
Budget Resolution to help them decide how to
divide money among federal agencies.
• Each Appropriations Committee creates 13 spending bills in each
house of Congress, which are then resolved in 13 separate
spending bills for federal agencies.
• Congress votes on the final version of each
spending bill.

40. CONGRESS
• Appropriations subcommittees hold many public
hearings to examine agency requests and take
testimony from lobbyists and others about
specific spending plans.
• Why do you think
these hearings
are open to the
public?

41. APPROVING THE BUDGET
• The total cost of all appropriations bills cannot be greater than
the maximum limit set by the Budget Committees.
• Each appropriations bill approved by Congress goes to the
President to be vetoed or signed into law.
• If, as often happens, an appropriations bill is not approved by
October 1, Congress must pass a continuing resolution to fund
any affected agencies to ensure their continued operation

42. FISCAL AND MONETARY POLICY
Section 4

43. INTRODUCTION
• How does the Federal Government achieve its
economic goals?
• The Federal Government tries to maintain a healthy, growing
economy through a combination of fiscal policies.
• These involve taxation, government spending and monetary
policies based on controlling the money supply and the
availability of credit.

44. OVERALL ECONOMIC GOALS
• The federal government seeks to achieve full
employment, price stability, and economic growth.
• Full employment means that everyone able and willing to work
can find a job.
• Price stability means that overall prices for goods and service do
not rise too high (inflation) or fall too low (deflation).
• Economic growth means that the gross domestic product (GDP)
steadily increases, avoiding recession.

45. OVERALL ECONOMIC GOALS
• High inflation means that dollars buy less than
they previously did, which robs people of
purchasing power.
• Deflation hurts the economy by making it harder
to borrow money and lowering the money
earned by farmers and other producers, who
receive less for their goods.

46. FISCAL POLICY
• Fiscal policy is the government’s attempt to influence
the economy through taxation and spending.
• In general, higher government spending increases
economy activity, while less spending dampens activity.
• Tax increases tend to slow economic growth, while tax
cuts boost growth.
• For many years, federal fiscal policy was limited. Very
little of GDP came from federal spending. Today,
federal spending accounts for about 20% of GDP.

47. FISCAL POLICY
• During economic downturns, policy makers
usually increase federal spending, cut taxes, or
both in hopes of expanding the economy.
• In theory, tax increases or cuts in federal
spending can slow inflation.

48. MONETARY POLICY
• Monetary policy involves increasing or decreasing the
money supply and easing or tightening the availability
of credit.
• The goal is to boost or slow down the economy as
needed.
• The seven-member Federal Reserve Board, or Fed,
carries out U.S. monetary policy. Members are
appointed to 14-year terms.
• The Fed also helps stabilize the banking system by
providing emergency funding.

49. MONETARY POLICY
• Under the guidance of current Chairperson Janet
Yellen, the Fed has three major tools for altering the
money supply:
• Open market operations
• Reserve requirements
• The discount rate

50. OPEN MARKET OPERATIONS
• The Federal Reserve carries out open market
operations by buying or selling government securities
to and from banks.
• Buying government securities gives banks more money to
loan to individuals and businesses. This can boost business
activity.
• Selling government bonds to banks removes money from
circulation, leaving banks with less money to loan or invest.
This slows business activity.

51. RESERVE REQUIREMENTS
• The reserve requirement is the amount of money that the
Federal Reserve requires banks to keep in their vaults or
on deposit with one of the 12 Federal Reserve Banks.
• Money kept in reserve cannot be loaned or spent—it is out
of circulation.
• Increasing the reserve requirement lowers the amount of
money in circulation, while decreasing the reserve
requirement does the opposite.

52. THE DISCOUNT RATE
• The discount rate is the interest
paid by banks borrowing from the
Federal Reserve.
• Raising the discount rate slows
borrowing, which reduces the
flow of money. Lowering it does
the opposite.
• How does this cartoon show
the complexity of monetary
policy?