1 Functions of GovernementUnit 6 Functions of Governement

2 How does the government make money (revenue)? What does the government spend money on (expenditures)?

3 Domestic Policy Government policies on issues within the country.Protect citizens Create a stable economy Providing public goods Guiding the nation

4 Government Revenue Taxes User Fees Selling Government bondsGovernment fines

5 “In this world, nothing is certain but death and taxes”Taxes And Spending “In this world, nothing is certain but death and taxes” -Benjamin Franklin

6 What are Taxes? Taxes are payments people are required to pay to local, state and national governments. Taxes are used to pay for services provided by government: Schools Police Defense Etc.

7 Taxes and the ConstitutionArticle 1, Section 8, Clause 1 of the Constitution grants Congress the power to tax. The Sixteenth Amendment gives Congress the power to levy an income tax.

8 Limits on the Power to TaxCertain taxes are prohibited or limited in the Constitution: The purpose of the tax must be for “the common defense and general welfare” Federal taxes must be the same in every state The government may not tax exports

9 Impact of Taxes Types of taxes affect people differently, depending on their income. 3 forms of taxes are: Progressive Tax Regressive Tax Proportional Tax

10 Progressive Tax Def. Tax designed to take a larger percentage of income from the wealthy than the poor. Argument for: the wealthy can afford a higher tax and should pay more of the tax burden. Argument against: why should the hardest working and most successful pay more taxes? Wealthy are penalized for their success. Ex. Income Tax with Tax Brackets

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12 Progressive Tax (cont.)A person making $20,000 pays 10% income tax ($2000). Their after tax income is $18,000. A person making $200,000 pays 30% tax ($60,000). Their after tax income is $140,000.

13 Regressive Tax Def. Tax which takes a higher percentage of income from the poor than from the rich. Ex. Sales Tax Argument for: Tax levied on what is bought. If you cannot afford the tax, do not buy the item. Argument against: Tax harms those who can least afford it.

14 Regressive Tax (cont.) Two people buy a $20,000 car. They both pay $1600 in sales tax. The first person makes $30,000. The sales tax is 5.3% of his income. He has $28,400 left after paying the tax. The second person makes $100,000. The sales tax is 1.6% of his income. He has $98,400 left after paying the tax.

15 Proportional Tax Def. A tax that takes the same percentage of income from the wealthy and poor. Argument for: Everyone is equal- pay same % of income. Argument against: The poor need their income more than the wealthy. They need every penny and cannot afford as much of a tax as the wealthy.

16 Proportional Tax (cont.)On a “Flat” Income tax of 20%: A person making $20,000 pays $4000, after tax income= $16,000 A person making $200,000 pays $40,000, after tax income= $160,000

17 Federal Income Taxes “Pay-as-You-Earn” Taxation Tax WithholdingFederal income taxes are collected throughout the course of the year as individuals earn income Tax Withholding The process by which employers take tax payments out of an employees pay before he or she receives it.

18 Federal Income Taxes (cont.)Tax Brackets The federal income tax is a progressive tax. In 1998, there were five rates, each of which applied to a different range of income. The percent taxed ranges from 10% for the lowest income to 35% for the highest of incomes.

19 Federal Income Taxes (cont.)Tax Returns: At the end of the year, an employer gives employees a report showing how much they withheld in taxes. Individuals file a tax return with information regarding exemptions and deductions that adjust the amount of tax that should have been paid. If you paid too much, you get a refund. If you paid too little, you must pay the balance. All tax returns must be filed by April 15th.

20 Social Security Taxes Provides funds for older Americans, their survivors, and disability insurance. Program funded by the Federal Insurance Contributions Act (FICA).

21 Medicare Funds a national health insurance for people over 65 and with certain disabilities. Paid through FICA.

22 Unemployment Taxes Paid for by employers, provides “unemployment compensation” for workers laid off through no fault of their own and are actively looking for work.

23 Other Taxes Excise Tax: tax on the sale or production of a good. Often used to discourage use of the item, called a “Luxuary” or “Sin” tax. Ex. Cigarettes, Alcohol, Gas, Telephone Estate Tax: Tax on the total value of money and property of a person who has died. Only taken on estates over $1.5 million. Opponents labeled it as the “Death Tax” because they believe it is unfair to wealthy, successful people.

24 Other Taxes (cont.) Gift Tax: Tax on money or property given as gift over $10,000 per year. Import Taxes: known as Tariffs, taxes on goods entering the U.S. Used to raise price of foreign goods and help American companies.

25 Ability to Pay PrincipleBenefit Received Principle The tax burden should be geared directly to one's income and wealth. Individuals and businesses with larger incomes should pay more It does not make any connection between use and payment but simply states that the individuals who are most able to bear the burden of the tax should pay the tax. Individuals who receive the benefit of a good or service should pay the tax necessary to supply that good or service. For example, gasoline taxes are typically earmarked for the financing of highway construction and repairs. Those who benefit from good roads pay the cost of those roads.

26 The Federal Budget Revenues (money coming in- taxes and bonds)- Expenditures (money going out-federal programs)

27 Federal Spending 2003 Where do my tax dollars go?

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29 Entitlement Programs Def. Social welfare programs that people are “entitled to” if they meet certain requirements. Congress must fund these programs. Entitlements are very expensive because Congress cannot control how many people receive the benefits. Ex. Social Security (#1spending), Medicare, Medicaid, Food Stamps, etc.

30 Medicare vs. Medicaid Medicare- Medical coverage for the elderly and disables. Medicaid- Medical coverage for low income individuals who meet certain income limits and other criteria such as age and family size .

31 Discretionary SpendingDef. Spending category where government can choose how to fund. Ex. Defense (#1 discretionary spending), education, research, student loans, technology, law enforcement, national parks and monuments, the environment, housing, transportation, disaster aid, foreign aid, farm subsidies, NASA etc.

32 Surplus/Deficits Balanced Budget: when the government collects the same in revenue (taxes) as it spends. Budget Surplus: When the government takes in more revenue than it spends. Budget Deficit: When the government spends more than it takes in.

33 Debt v. Deficit Deficit- the amount of money borrowed for one budgetDebt- the sum of all the deficits and surpluses 2004- deficit 400 billion, debt- 7 trillion

34 Problems with a National DebtReduces money available for business investments and slows economic growth The government must pay interest on the bonds

35 Deficits and SurplusesClinton administration had a surplus Budget enforcement act 1993- tax increase low unemployment George W. Bush- faced a deficit End of stock market boom 9-11 defense spending lower taxes

36 State and Local Taxes Louisiana, St. Tammany Parish, and The City of Mandeville all collect taxes from residents. These taxes pay for services within the state/parish/city/

37 State Taxes Sales Tax: Taxes on goods sold within the state. Not levied on food. Excise Tax: “Sin Tax” on sale of certain items ex. cigarettes, alcohol, gasoline. State Income Taxes Corporate Income Taxes: Taxes on corporations in the state

38 State Spending Education: State colleges, funding to public schoolsPublic Safety: State police, prisons Highways and transportation Public Welfare: Hospitals, unemployment Arts and Recreation: Parks, museums, historic sites State employees

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40 Local Taxes Property Tax: a tax levied on the value of property (real estate) owned. The main source of public school funding. Sales Tax: additional taxes above state sales tax. LA sales tax is 4%, St. Tammany Parish adds 4.75% for a total of 8.75% sales tax.

41 Local Spending Public Schools Law enforcement/Fire ProtectionLocal Parks/Recreation Public Health (hospitals, sewers, food inspectors) Public Transportation Social Services (food stamps, welfare, etc.) Records (Birth/Death certificates, marriage licenses)

42 Regulating the Economy

43 The Business cycle

44 Inflation and DeflationInflation: a general increase in prices and fall in the purchasing value of money. Deflation: reduction of the general level of prices in an economy.

45 Fiscal Policy The use of government spending and revenue collection to influence the economy

46 Expansionary Fiscal PolicyIs used when the economy may face a recession. Increased government spending – boosts the economy Cut taxes –gives consumers more money to spend

47 Contractionary Fiscal PolicyUsed to prevent inflation Decrease government spending Increase taxes- decrease the amount of money people have to spend

48 Classic Economics Adam Smith- The invisible handThis was the practiced belief until the Great Depression The market was not regulating itself and creating equilibrium Classic economics did not address how long it would take to reach equilibrium

49 Keynesian (Canes) EconomicsTo avoid recession or depression the government should monitor the private sector and adjust its fiscal policy to combat a decrease. To avoid inflation it should raise taxes and cut spending Developed by John Maynard Keynes Looked at the economy as a whole as opposed to individual products It examined the productive capability, or maximum output, an economy can produce without large increases in inflation

50 Keynesian (Canes) Economics (cont.)During the Great Depression- Businesses had no incentive to produce Consumers had no money to spend even though prices were low Someone had to jump start the economy. Keynes believed it was the responsibility of the government to do so.

51 Demand-Side EconomicsGovernment buys more goods and services and cuts taxes at the bottom for consumers and it will work its way to businesses More jobs are created People have more money to spend The government can cut spending

52 Keynesian (Canes) Economics (cont.)Increased government spending during WWII brought the US out of the Great Depression 1960’s tax cuts and government spending during Vietnam raised the US GDP 4%

53 Supply Side Economics (trickle down economics)Cut taxes and increase government spending at the top with businesses and it will trickle down to the people. Ex. 1980’s Regan lowered taxes by 25% over three years and the economy seemed to flourish, but the government was spending more money then it was making.

54 The Federal Reserve In Action

55 Monetary Policy is the process by which the monetary authority of a country controls the supply of money, often targeting a rate of interest for the purpose of promoting economic growth and stability. The official goals usually include relatively stable prices and low unemployment.

56 What is the Fed? Central bank of the United States Established in 1913Purpose is to ensure a stable economy for the nation through the regulation of the money supply. What is the Fed? The Federal Reserve is the central bank of the United States and its purpose is to help ensure a stable economy for the nation. Established as a result of the Federal Reserve Act, signed in 1913. Receives no congressionally appropriated funds. Its operations are financed primarily from the interest earned on the U.S. government securities it acquires in the course of its monetary policy actions. Another major source of income is derived from the fees received for certain services provided to depository institutions. After payment of certain expenses, all the net earnings of the Federal Reserve Banks are transferred to the U.S. Treasury. In 2004, for example, the Fed paid approximately $18.1 billion to the U.S. Treasury.

57 Roles & ResponsibilitiesConduct the nation’s monetary policy Reserve requirements Printing money Supervise and regulate banking institutions Operate a nationwide payments system Check clearing The responsibilities of the Federal Reserve System as a whole fall into the following three general areas: Conducting the nation’s monetary policy Supervising and regulating banking institutions Operating a nationwide payment system.

58 Federal Reserve System StructureBoard of Governors 12 Reserve Banks Federal Open Market Committee The Board of Governors in Washington, D.C. oversees the activities of the twelve independently operated District Reserve Banks across the country. Each of the 12 Federal Reserve Banks is separately incorporated with a Board of Directors. The District Federal Reserve Banks, along with their 25 branches, are located in major cities across the country, giving the System a strong grass-roots foundation. The Federal Open Market Committee (FOMC) is the chief policymaking body of the Federal Reserve System.

59 Where is my Fed? Reserve Banks are the decentralized components that carry out the Fed’s policies and activities at the regional level. Each bank is identified with a corresponding letter and number to identify Districts. There are several Divisions within the Fed that carry out its mandated responsibilities: Supervision & Regulation, Financial Services and Research.

60 Federal Reserve Banks Operate a nationwide payments systemDistribute the nation’s currency and coin Supervise and regulate member banks and bank holding companies Serve as banker for the U.S. Treasury Contribute to monetary policymaking through Bank presidents’ participation in the FOMC The Supervision & Regulation Division exists to promote the safety and soundness of the banking system, foster stability in financial markets, and ensure compliance with applicable laws and regulations. One of four federal regulatory agencies: Office of the Comptroller of the Currency (OCC) Federal Deposit Insurance Corporation (FDIC), Office of Thrift Supervision (OTS) Has oversight of bank holding companies and state-chartered banks that are members of the Federal Reserve System; examines the health of banks; analyzes proposed mergers and acquisitions of banks; and monitors banks’ management, capital levels, and quality of assets. Plays a major role in international banking activities overseeing U.S. banking organizations that conduct operations abroad; authorizing the establishment of foreign bank branches in the U.S.; establishing supervisory policy and practices regarding foreign lending of member banks. Responsible for implementing consumer protection laws, which cover almost all financial transactions involving consumers, including ATMs, credit cards, checking and savings accounts, and loans.

61 Supervision & RegulationPromote safety and soundness of banking system along with other regulatory bodies FDIC, OCC, OTS, state banking regulators Ensure compliance with laws and regulations Oversee international banking interests Administer consumer credit protection laws (truth-in-lending) The Supervision & Regulation Division exists to promote the safety and soundness of the banking system, foster stability in financial markets, and ensure compliance with applicable laws and regulations. One of four federal regulatory agencies: Office of the Comptroller of the Currency (OCC) Federal Deposit Insurance Corporation (FDIC), Office of Thrift Supervision (OTS) Has oversight of bank holding companies and state-chartered banks that are members of the Federal Reserve System; examines the health of banks; analyzes proposed mergers and acquisitions of banks; and monitors banks’ management, capital levels, and quality of assets. Plays a major role in international banking activities overseeing U.S. banking organizations that conduct operations abroad; authorizing the establishment of foreign bank branches in the U.S.; establishing supervisory policy and practices regarding foreign lending of member banks. Responsible for implementing consumer protection laws, which cover almost all financial transactions involving consumers, including ATMs, credit cards, checking and savings accounts, and loans.

62 Financial Services Supply currency and coin to banking institutionsClear more than one-third of nation’s checks Transfer funds electronically (ACH, Fedwire) Serve as bank for the U.S. Treasury The Financial Services Division is the operational area of the Bank. Responsible for supplying currency and coin to financial institutions. The Fed orders new currency from the Bureau of Engraving & Printing, and coin from the U.S. Mint, and is responsible for destroying unfit currency. As a provider of check clearing services, the Fed processes about 1/3 of all of the checks written in the U.S. The Automated Clearinghouse (or ACH) is an electronic form of payments processing, which you may be familiar with if you work and get your pay deposited directly into your account. Another example of electronic payments processing is FedWire, which is utilized primarily by financial institutions to transfer very large sums of money electronically. The Fed acts as the fiscal agent (bank) for the United States Treasury.

63 Research Gather, analyze and disseminate economic dataFocus on all aspects of the economy (regional to international levels) Analyze regional and national markets and economic data Design and test econometric models used to produce hard data that factor into policymaking decisions The Research Division is comprised of economists at the Reserve Banks and the Board of Governors. The primary responsibility of the research economists is to prepare the Reserve Bank presidents for his or her participation in FOMC meetings. Members of the research staff gather, analyze and disseminate information about the economy. Focus on every aspect of the economy, from the regional level to the international level, and studies range from analyzing regional banking markets to designing and testing econometric forecasting models to predict the outcome of various economic scenarios. The economists are looking for key pieces of information that will contribute to better monetary policymaking.

64 Monetary Policy Policy changes affect the nation’s supply of money and credit. Actions have real short- and long-term effects on the economy. What is monetary policy? The Fed manages the nation’s money supply to keep inflation low and the economy growing at a sustainable rate. The actions that the Fed takes today influence the economy and the inflation rate for some time to come. Consequently, policymakers must be forward-looking and must take pre-emptive action to head off inflation before it gathers momentum

65 Goals of Monetary PolicyStable Prices Sustainable Economic Growth Full Employment Monetary policy is designed to effectively promote the goals of maximum employment, stable prices, and sustainable economic growth. The Fed is consistently striving for a balance between oftentimes conflicting goals of monetary policy For example, if the economy is growing at too rapid a pace, the Fed may dampen that growth by influencing interest rates to rise, which may have the effect of putting some people out of work—a direct challenge to the goal of maximum employment.

66 Fractional Reserve BankingBanks must keep a percentage of their deposits on hand (around 10%). Used for customer withdraws.

67 Money Expansion Banks lend money to other banks Then the money is lent to other banks or consumers This creates new money

68 Key Tools of Monetary PolicyDiscount Rate The interest rate charged by the Federal Reserve to banks that borrow on a short-term (usually overnight) basis Reserve Requirements The amount of money banks must keep on reserve at the Fed Open Market Operations Buying and selling Treasury securities between the Fed and selected financial institutions in the open market Most important tool; directed by the FOMC The tools the Fed utilizes to influence the economy (or affect the amount of funds in the banking system) are: Discount Rate: Rate of interest charged to banks that need to borrow from the Fed to cover temporary deposit drains (short-term “discount window” loans). Reserve Requirements: Portions of deposits that banks must hold in reserve, either in their vaults or on deposit at a Reserve bank. Federal Open Market Operations: The most frequently used and most flexible tool is that of Open Market Operations, which involves the buying and selling of U.S. government securities. This tool is directed by the FOMC and carried out at the domestic trading desk at the Federal Reserve Bank of New York

69 Key Federal Reserve Interest RatesFederal Funds Rate The market-based interest rate which banks charge each other on overnight loans of their reserve balances held at the Fed. The Fed achieves this rate through Open Market Operations. A target rate Discount Rate Applies to short-term loans made directly to commercial banks from the Federal Reserve System. Typically set at 1 percentage point above the Federal Funds Rate. Discount Rate Applies to loans made directly to commercial banks from the Federal Reserve System Typically set at one percentage point above the Federal Funds Rate – incentive not to borrow from the Lender of Last Resort Federal Funds Rate The lowest of short-term market interest rates which banks charge each other on overnight loans. The Fed achieves this rate through Open Market Operations.

70 Expand the economy Credit is cheap and plentifulLoose money policy Expand the economy Credit is cheap and plentiful

71 Effects of Low Interest Rates (Discount Rate)-Generally, low interest rates stimulate the economy because there is more money available to lend. Consumers buy cars and houses. Businesses expand, buy equipment, etc. Why does the Fed lower interest rates? If inflation is in check, lower rates stimulate economic activity, thus boosting economic growth. Impact of Lowering Rates: The cost of borrowing money goes down. Induced consumer spending increases economic activity. Low interest rates cut the cost of capital for businesses and improve profit margins and encourages expansion.

72 Reserve Requirements Lower reserve requirements lead to an expansion of the economy Banks have more money on hand to lend. Encourages investments and business expansion

73 Federal Open Market OperationsBuying and selling of government securities. When the fed sells securities it deposits money into the banks account giving them money to lend The Federal Open Market Committee (FOMC) is the primary group responsible for formulating and implementing monetary policy. Seven Fed governors and the twelve Bank Presidents participate in the economic discussions at each meeting, with the Reserve Bank Presidents bringing to the table regional economic news gleaned from their local boards of directors and staff economists. Every president and each of the governors are given an opportunity to present their opinions. Twelve of the 19 members vote at the meetings—all seven governors and five of the Reserve Bank Presidents, with the president of the New York Fed always a voting member, because Open Market Operations are carried out at the trading desk of the New York Fed. The other four voting positions rotate yearly among the remaining eleven Reserve Bank presidents. Policy changes are decided by consensus and are announced immediately following each meeting.

74 Slow the economy Credit is in short supply and expensiveTight Money Policy Slow the economy Credit is in short supply and expensive

75 Effects of High Interest Rates (Discount Rate)-The Fed raises interest rates as an effective way to fight inflation. Inflation—a sustained rise in the general price level; that is, all prices are rising together. Consumers pay more to borrow money, dampening spending. Businesses have difficulty borrowing; unemployment rises. The Fed generally raises rates as an effective way to quell inflation (a sustained rise in the general price level). Inflation means that your money is worth less Impact of Raising Rates: Businesses have difficulty in obtaining loans for expansion; unemployment rises Consumers will pay higher interest rates on credit cards and mortgages, which can cool spending.

76 Reserve Requirements Raising the reserve requirements decreases the amount of money available for investment.

77 Federal Open Market OperationsBuying and selling of government securities. When the fed buys securities it takes money out of the banks account giving them less money to lend The Federal Open Market Committee (FOMC) is the primary group responsible for formulating and implementing monetary policy. Seven Fed governors and the twelve Bank Presidents participate in the economic discussions at each meeting, with the Reserve Bank Presidents bringing to the table regional economic news gleaned from their local boards of directors and staff economists. Every president and each of the governors are given an opportunity to present their opinions. Twelve of the 19 members vote at the meetings—all seven governors and five of the Reserve Bank Presidents, with the president of the New York Fed always a voting member, because Open Market Operations are carried out at the trading desk of the New York Fed. The other four voting positions rotate yearly among the remaining eleven Reserve Bank presidents. Policy changes are decided by consensus and are announced immediately following each meeting.

78 Issues with Monetary PolicyHard to gather information Fiscal policy can conflict with monetary policy Answers: Conducting the nation’s monetary policy, Supervising and regulating banking institutions, and operating a nationwide payment system. Results will vary Maximum employment, price stability, sustainable economic growth Lower rates induce economic activity; higher rates calm inflation, slows down spending Inflation is a sustained increase in the general price level; inflation is a concern because it means your money is worth less over time. The Federal Open Market Committee (FOMC) Discount Rate – the rate of interest charged to banks who borrow money from the Federal Reserve; Fed Funds Rate – the rate of interest banks charge each other to borrow money.

79 Fiscal vs. Monetary policyFiscal policy Monetary policy Congress Federal budget Taxes Government spending Expansionary policy Contractionary policy The Fed Money supply/creation Reserve rations Open Market operations Interest rates (discount rates) Loose (easy) money Tight money