Chapter Overviews

Chapter 20: Taxing and Spending

Chapter Overviews

[logo] Essential Question
How does the government spend the taxes you pay, and how do government expenditures affect the economy?

Section 1 Raising Money
Two major sources of government revenue are taxes and borrowing. The individual income tax is the federal government's biggest single source of revenue. Employers withhold a certain amount of money from workers' wages and send this money to the Internal Revenue Service throughout the year. Corporations must also pay income taxes. Nonprofit organizations are exempt. The federal government also collects huge sums of social insurance taxes to pay for Social Security, Medicare, and unemployment compensation programs. Other forms of taxes include excise taxes on the manufacture, transportation, sale, or consumption of certain goods and services; customs duties; and estate and gift taxes.

Governments use taxes to influence the economy and economic behavior. Tax deductions for mortgage interest encourage people to buy homes, for example. Tax exemptions free certain groups and industries from particular taxpaying obligations. The Tax Reform Act of 1986 overhauled the tax system.

In addition to collecting taxes, the federal government borrows money by selling federal securities—bonds, notes, and treasury bills. Small investors purchase savings bonds. The government pays a huge amount of interest on these borrowed funds. When the government spends more than its income, it runs a deficit. All the deficits over time create the national debt.

Section 2 Preparing the Federal Budget
The federal budget expresses important political choices by the president's administration. The law requires the president to propose to Congress the budget for the entire federal government each fiscal year. The actual preparation of the budget is the responsibility of the Office of Management and Budget (OMB). Each federal agency draws up a list of its own spending plans and sends these to the OMB. The president and his advisers study this preliminary budget and send the spending requests back to the agencies for fine-tuning. After a final presidential review, the budget is sent to Congress. Certain items in the budget cannot be changed, such as entitlements and the interest that must be paid on the national debt.

The Congressional Budget Office (CBO) carefully evaluates the president's budget for the House and Senate. The House and Senate Budget Committees review the budget, reconcile differences between their two versions of the budget, and make sure the budget aligns with the Budgetary Enforcement Act of 1990. After the budget is approved, the House passes an appropriations bill, officially setting aside money for expenditures.

Section 3 Managing the Economy
The federal government plays an increasing role in managing the nation's economy. It spends roughly $3 trillion per year on four major components: direct benefit payments to individuals, national defense, discretionary spending, and interest on the national debt. The government influences the economy in two ways: through fiscal policy and monetary policy. Fiscal policy involves using government spending and taxation to either stimulate or slow down the economy. Monetary policy involves controlling the supply of money and the cost of borrowing, or credit. The Federal Reserve System is in charge of monetary policy.

The Fed—the central banking system of the United States—is a banker's bank. The United States is divided into 12 Federal Reserve Districts, each with one main Federal Reserve Bank and additional branch banks. These member banks control the largest share of total bank deposits in the country. A seven-member Board of Governors in Washington, D.C., supervises the Fed. It determines the general money and credit policies of the United States, and it supervises the Fed member banks. The Fed uses four main tools to control the financial activities of banks and monetary policy. The Fed can raise or lower the discount rate or reserve requirements. It can put money into the economy by buying government securities. It can also take money out of the economy by selling securities.