After reading Special Topic 1 and Special Topic 2, write a 2-page paper answering and describing: Can democracy survive if a majority of the citizenry pay little or nothing in taxes while benefiting directly from a higher level of government spending? Why or why not? Discuss.
Special Topic 1 Key points Government Spending and Taxation
During the first 125 years of U.S. history, federal expenditures per person were small and grew at a relatively slow rate. But the size and nature of government has changed dramatically during the past 100 years. Today, the real (adjusted for inflation) spending per person of the federal government is roughly 75 times the level of 1916.
During the last five decades, the composition of federal spending has shifted away from national defense and toward spending on income transfers and health care.
As the size of government has grown, taxes have increased. Taxes impose a burden on the economy over and above the revenue transferred to the government because of
(1)
the administration and compliance costs and
(2)
the deadweight losses that accompany taxation.
Overall, the federal tax system of the United States is highly progressive. Taxes as a percentage of income are approximately 12 times greater for the top quintile (20 percent) of families than for the bottom quintile.
The size of government of the United States is smaller than that of the major Western European countries but is larger than for a number of high-growth Asian economies.
When governments focus on the core activities of providing
(1)
a legal and enforcement structure that protects people and their property from aggression by others and
(2)
a limited set of public goods, they promote economic growth.
However, when governments grow beyond this size, expanding into activities for which they are ill suited, they deter growth.
More than half of American families derive benefits from various transfer programs, while the share of the population paying federal income tax has declined substantially during the past decade. Moreover, large budget deficits have pushed the debt to GDP ratio to levels not seen since the aftermath of World War II. These factors, along with upward pressure on expenditures for Social Security and Medicare as the baby-boomers retire, will make it very difficult to control federal finances. Thus, the United States confronts a troublesome fiscal future in the years immediately ahead.
Special Topic 2 Key Points The Economics of Social Security
Social Security does not follow the saving-and-investment model. Most of the taxes paid into the system are used to finance the benefits of current retirees.
As the baby-boomers began moving into the retirement phase of life in 2010, the Social Security system shifted from a surplus to a deficit. The deficits will persist and become larger and larger in the decades immediately ahead.
The previous surpluses of the Social Security system were used to cover current expenditures, and the U.S. Treasury provided the Social Security Administration with nonmarketable bonds. Because the federal government is the payee and the recipient of these bonds, their net asset value to the federal government is zero. They will not reduce the level of future taxes needed to cover the Social Security deficits.
The major problem resulting from the current pay-as-you-go system is that large tax increases, spending cuts, or additional borrowing will be required to cover the Social Security deficits following the retirement of the baby-boom generation.
Whereas the Social Security benefit formula favors those with lower lifetime earnings, low-wage workers have a lower life expectancy, begin work at a younger age, and gain less from the spousal benefit provisions of the current system. These latter factors largely, if not entirely, offset the egalitarian effects of the benefit formula.
Because of their shorter life expectancy, blacks derive a lower rate of return from Social Security than whites and a substantially lower return than Hispanics.
The demographics of the twenty-first century reduce the attractiveness of pay-as-you-go Social Security. Various plans that would place more emphasis on saving and investment are likely to be considered in the future.
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