Chapter 15

Federal Budgets: The Tools of Fiscal Policy

Concept Map

I.  How Does the Government Spend?

A.  Government Outlays

B.  Social Security and Medicare

1.  Social Security

2.  Medicare

3.  Demographics

4.  Fixing Social Security and Medicare

C.  Spending and Current Fiscal Issues

II.  How Does the Government Tax?

A.  Sources of Tax Revenue

B.  Payroll Taxes

1.  Social Insurance Taxes

2.  Income Tax

a.  Historical Income Tax Rates

C.  Who Pays for Government?

III.  What Are Budget Deficits, and How Bad Are They?

A.  Deficits

B.  Deficits versus Debt

1.  European Debt

C.  Foreign Ownership of U.S. Federal Debt

1.  Does China Own the United States?

MULTIPLE-CHOICE QUESTIONS

1.  A budget is:

a.  a record of income and purchases from the previous year.

b.  a plan for spending and earning money.

c.  only necessary for individuals with low incomes.

d.  only necessary for countries suffering from financial crises.

e.  required to be balanced by Congress.

2.  Should average citizens be concerned with the government’s budget?

a.  No, because the government’s spending and tax policies do not affect citizens.

b.  No, because even if citizens do not like the budget, there is nothing they can do to influence it.

c.  No, because the government is not spending the average citizen’s money; therefore, the average citizen has no incentive to monitor the government’s budget.

d.  Yes, because an important part of civic duty is voting on the yearly budget.

e.  Yes, because the government’s yearly budget decisions have immediate and future implications for levels of taxation and the provision of public goods.

3.  Today, total annual government outlays in the United States are:

a.  over $3 trillion.

b.  over $6 trillion.

c.  over $16 trillion.

d.  less than $1 trillion.

e.  equal to total annual revenue.

4.  Between 2000 and 2010, real government outlays in the United States grew:

a.  by less than 50%.

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c.  by more than 75%.

d.  by more than 100%.

e.  by less than 30%.

5.  The largest portion of the federal budget is dedicated to:

a.  discretionary spending.

b.  mandatory outlays.

c.  interest payments.

d.  tax collection.

e.  defense spending.

6.  Which of the following is considered mandatory government spending?

a.  funding for the Environmental Protection Agency

b.  payments to active military personnel

c.  infrastructure maintenance spending

d.  international aid to poor countries

e.  payments to Social Security recipients

7.  Which federal budget category’s portion of total government outlays has decreased since 1960?

a.  Social Security

b.  Medicare

c.  Medicaid

d.  defense

e.  food stamps

8.  Transfer payments refer to funds that are transferred from one group in society to another group:

a.  so these payments have no impact on the government budget deficit.

b.  so these payments have no impact on the government debt.

c.  so these payments are unfair to those who lose money in the transfer.

d.  and these payments represent a growing share of U.S. federal outlays.

e.  and these payments remain approximately constant over time.

9.  Mandatory outlays are different than discretionary outlays because:

a.  mandatory outlays usually change during the budget process, whereas discretionary outlays do not.

b.  mandatory outlays have been decreasing as a percentage of the federal budget, whereas discretionary outlays have been increasing as a percentage of the federal budget.

c.  discretionary outlays can be changed during the annual budget process, whereas mandatory outlays cannot.

d.  discretionary outlays include entitlement programs (such as Social Security and Medicare), whereas mandatory outlays include important government programs (such as defense).

e.  discretionary outlays comprise the vast majority of the total budget, whereas mandatory outlays make up only a minor fraction.

10.  Why are interest payments considered mandatory spending in the federal budget?

a.  They are considered mandatory spending because such payments are fixed at the time of borrowing and cannot be altered.

b.  They are considered mandatory spending because the interest rates on federal debt are extremely high, and failing to pay accumulated interest would dramatically increase the total debt.

c.  They are considered mandatory spending because not making such payments could endanger the government’s credit rating, which could make it harder to borrow going forward.

d.  They are considered mandatory spending because interest payments constitute the largest part of yearly government spending.

e.  They are considered mandatory spending because most interest payments go to American households and those citizens depend on the interest payments for their livelihoods.

11.  Mandatory outlays:

a.  usually change during the budget process.

b.  cannot be altered once they are made into law.

c.  require changes in existing laws if those outlays are to be altered.

d.  are a minor component of total outlays, and so are usually ignored.

e.  are another name for discretionary outlays.

12.  Which of the following is considered discretionary government spending?

a.  payments to Social Security recipients

b.  payments to unemployment insurance recipients

c.  payments to government employees

d.  payments to food stamp recipients

e.  payments to foreign bondholders

13.  Assuming all of the following are in your personal monthly budget, your _____________ payment is considered a discretionary outlay.

a.  mortgage (or rent, if you do not own a home)

b.  car loan

c.  student loan

d.  electric bill

e.  boat loan

14.  _____________ would be considered a mandatory outlay in your monthly budget.

a.  A student loan payment

b.  A donation to your alma mater

c.  A grocery bill

d.  Your electric bill

e.  Gasoline money (for travel to and from work)

15.  Discretionary government spending includes payments made for:

a.  children’s health insurance program.

b.  deposit insurance payments.

c.  unemployment compensation.

d.  the Department of Education.

e.  pension payments for retired Coast Guard officers.

16.  Due to ____________, government outlays have risen quickly since 2000.

a.  less tax revenue

b.  an aging population

c.  increased government borrowing

d.  economic expansion

e.  lower interest payments on current government debt

17.  ____________ a government-administered retirement program.

a.  Medicare is

b.  Medicaid is

c.  Unemployment compensation is

d.  Social Security is

e.  Food stamps are

18.  When Social Security was first instituted by President Franklin Roosevelt in 1935, the payroll tax rate on wages used to fund the program was:

a.  1%.

b.  2%.

c.  3%.

d.  4%.

e.  5%.

19.  ____________ a mandated federal program that funds health care for retired persons.

a.  Medicare is

b.  Medicaid is

c.  Unemployment compensation is

d.  Social Security is

e.  Food stamps are

20.  The funds used for payments to Medicare recipients come primarily from:

a.  government borrowing.

b.  donations from charitable organizations and citizens.

c.  the employee’s portion of payroll taxes only.

d.  the employer’s portion of payroll taxes only.

e.  both the employer’s and employee’s portion of payroll taxes.

21.  The number of workers per Social Security beneficiary in 1960 was approximately:

a.  2.1.

b.  3.1.

c.  4.1.

d.  5.1.

e.  6.1.

.   3.

22.  Over the next 20 years, the number of workers per Social Security beneficiary is predicted to be:

a.  more than 5.

b.  less than 5 but more than 3.

c.  less than 3 but more than 2.

d.  less than 2 but more than 1.

e.  less than 1.

.   3.

23.  Social Security and Medicare spending continue to grow and take up larger shares of the federal budget because:

a.  life expectancy is increasing, the number of people receiving benefits is increasing quickly, and the growth in the number of people paying into the programs is decreasing.

b.  life expectancy is decreasing, the number of people receiving benefits is increasing quickly, and the growth in the number of people paying into the programs is decreasing.

c.  life expectancy is increasing, the number of people receiving benefits is decreasing quickly, and the growth in the number of people paying into the programs is decreasing.

d.  life expectancy is increasing, the number of people receiving benefits is increasing quickly, and the growth in the number of people paying into the programs is increasing.

e.  life expectancy is decreasing, the number of people receiving benefits is decreasing quickly, and the growth in the number of people paying into the programs is increasing.

DIF: Difficult  TOP: I.B.3.

24.  Are demographics an important factor when planning the federal budget?

a.  No, because government spending and taxation policies do not discriminate based on any demographic factors.

b.  No, because demographics do not change much from year to year.

c.  No, because federal budgets do not change much from year to year.

d.  Yes, because government benefits are allocated solely based on demographic factors.

e.  Yes, because many government benefits are received by the fast-growing elderly population, causing implications for future levels of taxation and government benefits for everyone.

.

25.  Why do Social Security and Medicare pose problems for the federal government budget?

a.  The worker-to-retiree ratio is increasing.

b.  Payroll taxes are capped and cannot be raised.

c.  The number of retirees is decreasing.

d.  The number of sick people is rising too quickly.

e.  Life expectancy of retirees is increasing.

26.  Why do Social Security and Medicare pose problems for the federal government budget?

a.  The number of retirees is increasing.

b.  The worker-to-retiree ratio is increasing.

c.  Life expectancy is decreasing.

d.  The number of sick people is rising too quickly.

e.  Social insurance taxes cannot legally be raised any further.

27.  Why do Social Security and Medicare pose problems for the federal government budget?

a.  The programs do not cover enough people.

b.  The worker-to-retiree ratio is decreasing.

c.  The number of retirees is decreasing.

d.  The number of sick people is rising too quickly.

e.  Social insurance taxes are capped and cannot be raised.

28.  One proposed solution to the funding problems faced by Social Security and Medicare is to implement means-testing, so that only those with limited retirement funds would qualify for the government benefits. An unintended consequence of such a requirement may be:

a.  an increase in private saving.

b.  an increase in black market activity.

c.  improved solvency for Social Security and Medicare.

d.  fewer elderly people receiving benefits.

e.  that some workers paying into the programs never receive any benefits from the programs.

.

29.  One proposed solution to the funding problems faced by Social Security and Medicare is to increase the retirement age from 67 to 70. Although this would mean billions of dollars in savings for these federal programs, an unintended consequence may be:

a.  a decrease in life expectancy.

b.  an increase in the unemployment rate.

c.  an increased number of elderly people in the workforce.

d.  less incentive for people to work longer.

e.  an increased incentive for people to work longer.

.

30.  Some proponents of entitlement-program reform suggest indexing Social Security benefits to the consumer price index (CPI):

a.  because beneficiary payments are not currently adjusted for cost of living increases.

b.  rather than to the producer price index, because CPI historically grows at a faster rate, which would mean benefit payments would grow at a faster rate.

c.  rather than to the producer price index, because CPI historically grows at a slower rate, which would mean benefit payments would grow at a slower rate.

d.  rather than to the average wage index, because CPI historically grows at a slower rate, which would mean benefit payments would grow at a slower rate.

e.  rather than to the average wage index, because CPI historically grows at a faster rate, which would mean benefit payments would grow at a faster rate.

.

31.  Reforming entitlement programs is difficult because:

a.  there is very little support for reform.

b.  there are no good ideas for effective reform.

c.  reforms require changes to existing law, which takes time.

d.  all the reforms proposed are only short-term solutions.

e.  the proposed reforms all require increases in existing tax rates, which are difficult to achieve politically.

.

32.  Federal government spending has grown quickly since 2007 primarily because of:

a.  expansionary fiscal policy in response to the Great Recession.

b.  increased spending on bridge and road infrastructure.

c.  increased foreign aid to disaster-stricken areas.

d.  increased spending on the U.S. education system.

e.  the bailout payments made to big banks.

.

33.  Which of the following is not a revenue source for the U.S. federal government?

a.  sales taxes

b.  federal gasoline taxes

c.  federal income taxes

d.  payroll taxes

e.  admission fees for national parks

34.  In 2012, revenue from corporate income taxes totaled approximately:

a.  5% of total revenue.

b.  10% of total revenue.

c.  15% of total revenue.

d.  20% of total revenue.

e.  25% of total revenue.

35.  Excise taxes are levied on:

a.  property that is gifted to others.

b.  imports.

c.  individual income.

d.  corporate income.

e.  specific goods or commodities.

36.  Social Security and Medicare are funded by the collection of:

a.  individual income taxes.

b.  corporate income taxes.

c.  payroll taxes.

d.  excise taxes.

e.  sales taxes.

37.  The largest source of tax revenue for the government is:

a.  individual income taxes.

b.  corporate income taxes.

c.  social insurance taxes.

d.  estate taxes.

e.  excise taxes.

REF: Sources of Tax Revenue

38.  Which of the following is an example of something that contains an excise tax?

a.  property

b.  income

c.  clothing made and sold in Oregon (where the sales tax rate is 0%)

d.  clothing imported from China and sold in Oregon

e.  tobacco products

.

39.  The government withdraws social insurance taxes from the paychecks of workers to:

a.  discourage people from working.

b.  pay the salaries of the members of Congress.

c.  reduce the incidence of elderly poverty.

d.  penalize wealthy workers.

e.  collect money for international aid.

40.  The total current tax rate for Social Security and Medicare is:

a.  3.9%.

b.  6.2%.

c.  12.4%.

d.  15.3%.

e.  16.5%.

41.  The current tax rate for Social Security is:

a.  7.65% for the employee and 7.65% for the employer, if not self-employed.

b.  7.65%, if self-employed.

c.  6.2% for the employee and 6.2% for the employer, if not self-employed.

d.  1.45% for the employee and 1.45% for the employer, if not self-employed.

e.  12.4%, if self-employed.

42   Some people argue that social insurance taxes should be increased to remedy the fiscal problems faced by Social Security. What is a potential problem with this proposed solution?

a.  This solution might only be a temporary fix, as it does not address the fundamental issue of a growing elderly population and a shrinking working population.

b.  It puts too much of the burden on the middle class and not enough on wealthy households.

c.  It would eliminate the need for private savings, thus hurting banks.

d.  This solution does not address the fact that the number of retirees is increasing.

e.  Payroll taxes cannot be increased high enough to solve the problem.

43.  Payroll taxes:

a.  are not paid by individuals who are self-employed.

b.  generate revenues earmarked for mandatory spending purposes.

c.  generate revenues earmarked for discretionary spending purposes.

d.  are based solely on income.

e.  are not paid by people making over $110,100.

44.  Some people argue that social insurance taxes should be increased to remedy the fiscal problems faced by Social Security. What is a potential unintended consequence of this proposed solution?

a.  Federal tax revenues may increase.

b.  The tax burden of the average worker may increase.

c.  The disposable income of workers may decrease.

d.  The elderly poverty rate may decrease.

e.  The unemployment rate may increase.

DIF: Difficult  TOP: II.B.1.

45.  Suppose you return to college and earn an MBA, after which you get an upper-management position with Yum! Brands. If the tax rates are the same as in 2012 and your starting salary is $125,000, how much will you owe in federal social insurance taxes?

a.  more than $8,800

b.  more than $8,400 but less than $8,800

c.  more than $7,900 but less than $8,400

d.  more than $7,300 but less than $7,900

e.  less than $7,300

46.  Suppose you return to college and earn an MBA, after which you get an upper-management position with Yum! Brands. If your starting salary is $125,000, and the percentages are the same as they were in 2012, how much will you owe in Social Security taxes?

a.  more than $8,800

b.  more than $8,400 but less than $8,800

c.  more than $7,900 but less than $8,400

d.  more than $7,300 but less than $7,900

e.  less than $7,300

DIF: Medium TOP: II.B.1.

47.  Suppose you land a job with Google right out of college. Your economics training is very valuable to them, so you receive a starting annual salary of $65,000. What is the total amount of social insurance taxes you will be responsible for after your first year of work?

a.  $9,945.00

b.  $4,030.00

c.  $942.50

d.  $9,750.00

e.  $4,972.50

48.  Suppose you use your entrepreneurial spirit and economics training to start your own business. In your first year of work, you are able to earn $58,000 in gross income. What is the total amount of social insurance taxes you owe the federal government?

a.  $4,437.00

b.  $7,192.00

c.  $8,874.00

d.  $3,596.00

e.  $8,700.00

49.  The United States has a:

a.  progressive income tax system.

b.  regressive income tax system.

c.  marginal income tax system.

d.  good income tax system.

e.  bad income tax system.

50.  A progressive income tax system is one in which:

a.  income tax rates decrease as earned income increases.

b.  everyone pays the same tax rate, so that wealthier people pay a larger sum of taxes.

c.  everyone pays the same tax rate, so that people with low incomes pay a smaller sum of taxes.

d.  income tax rates increase as earned income increases.

e.  incomes taxes are based on occupation.

51.  A marginal tax rate is:

a.  the tax rate paid on a worker’s next dollar of income.

b.  equal to a worker’s income tax bracket.

c.  the total tax paid divided by the amount of taxable income.

d.  irrelevant for making decisions about earning extra income.

e.  applied only to high earners under a progressive income tax system.

52.  If policymakers are concerned about the unequal distribution of income within society, then they should prefer a:

a.  regressive income tax system.

b.  progressive income tax system.

c.  consumption tax system.

d.  proportional income tax system.

e.  per capita tax system.

53.  The most relevant tax rate for making decisions about earning additional income is the:

a.  marginal tax rate.

b.  income tax rate.

c.  average tax rate.

d.  sales tax rate.

e.  property tax rate.

54.  Suppose you graduate with an accounting degree and then become a certified public accountant. You work for a big firm, but are offered a chance to prepare tax documents for your city government as an independent contractor. The city offers to pay you a consulting fee of $10,000. When deciding whether to accept the additional work, the most important tax factor in your decision is:

a.  the gross amount of the payment.

b.  your current tax bracket.

c.  your new average tax rate.

d.  which political party controls the city government.

e.  your marginal tax rate.

55.  Typically, the average tax rate for a person is ____________ their marginal tax rate, because ____________.

a.  below; the marginal tax rate applies to all income

b.  below; the marginal tax rate applies to the first dollars taxed, but not to all income

c.  below; the marginal tax rate applies to the last dollars taxed, but not to all income

d.  above; the marginal tax rate applies to the last dollars taxed, but not to all income

e.  above; the marginal tax rate applies to the first dollars taxed, but not to all income

56.  Suppose you are offered a $5,000 raise at work. Your current income tax rate is 25%. Your marginal income tax rate is 28%. Your average tax rate is 20%. The additional income tax you owe to the federal government (assuming you stay in the same rate bracket) if you accept the job will be:

a.  $1,250.

b.  $1,400.

c.  $1,000.

d.  $250.

e.  $150.

57.  Suppose you are offered a job with Amazon upon graduation. Your starting salary will be $70,000, which will put you in the 25% federal income tax bracket. The total amount of income taxes you pay is $13,530. Your average tax rate is approximately:

a.  25.0%.

b.  37.5%.

c.  31.3%.

d.  19.3%.

e.  12.5%.

58.  According to the U.S. Federal Tax Rates chart from the textbook (Figure 15.6), a person earning $100,000 in a given year is in the 28% tax bracket. How much will this individual owe in taxes for that year?

a.  $0

b.  $28,000

c.  more than $28,000

d.  less than $28,000 but greater than $15,000

e.  greater than $0 but less than $15,000

Refer to the following table to answer the next seven questions:

2012 Federal Income Tax Brackets

Taxable Income

Tax Rate

$0–$8,700

10%

$8,701–$35,350

15%

$35,351–$85,650

25%

$85,651–$178,650

28%

$178,651–$388,350

33%

Over $388,350

35%

59.  Using the table, what is the total federal income tax bill for someone who makes $67,000 per year?

a.  $16,750

b.  $12,780

c.  $11,169

d.  $10,050

e.  $6,700

60.  Using the table, what is the average tax rate for someone who makes $67,000 per year?

a.  10.0%

b.  14.2%

c.  16.7%

d.  25.0%

e.  19.1%

61.  Using the table, what is the marginal income tax rate for someone who makes $67,000 per year?

a.  10.0%

b.  14.2%

c.  16.7%

d.  25.0%

e.  19.1%

62.  Using the table, what is the total payroll tax bill (assume zero state and local income taxes) for someone who makes $67,000 per year?

a.  $17,905.25

b.  $23,030.75

c.  $13,751.25

d.  $16,933.75

e.  $5,125.50

DIF: Medium TOP: II.B.2.

63.  Using the table, what is the marginal income tax rate of a $5,000 raise for someone who currently makes $67,000 per year?

a.  10%

b.  15%

c.  25%

d.  28%

e.  0%

64.  Using the table, what is the marginal income tax rate of a $5,000 raise for someone who currently makes $85,650 per year?

a.  10%

b.  15%

c.  25%

d.  28%

e.  0%

65.  Using the table, what is the new average tax rate for a person who currently makes $80,000 per year and receives a $10,000 raise?

a.  20.7%

b.  20.0%

c.  28.0%

d.  27.5%

e.  22.3%

DIF: Difficult  TOP: II.B.2.

66.  The U.S. federal income tax began in:

a.  1910.

b.  1911.

c.  1912.

d.  1913.