Chapter 9: Sources of Government Revenue
 An enormous amount of money is required to run the federal, state, and local
governments of the United States.
A) Economic Impact of Taxes

Taxes and other governmental revenues influence the economy by affecting resource
allocation, consumer behavior, and the nation’s productivity and growth
a. Resource Allocation – a tax is placed on a good or service at the factory raises
the cost of production and makes the equilibrium price go up.
b. Behavior Adjustment – Often taxes are used to encourage or discourage
certain types of activities.
i. Sin Tax – a relatively high tax designed to raise revenue and reduce
consumption of a socially undesirable product such as liquor or
tobacco
c. Productivity and Growth – taxes can affect productivity and economic growth
by changing the incentives to save, invest, and work.
d. The Incidence of a Tax – the party being taxed is not always the one that pays
the tax. It is passed onto the consumer.
B) Criteria for Effective Taxes

Some taxes will always be needed, so we want to make them as effective as possible.
a. Equity – equity or fairness. People must believe that the tax is fair. There is
no guide that we can use to make taxes completely equitable. Taxes are
viewed as fair if they have fewer exceptions, deductions, and exemptions.
b. Simplicity – Tax laws should be written so that both the taxpayer and the tax
collector can understand them.
i. Individual Income tax – the tax on people’s earning is a prime example
of a complex tax. Many people dislike the individual income tax code,
in part because they do not fully understand it.
ii. Sale Tax – a general tax levied on most consumer purchases.
c. Efficiency – easy to administer and reasonably successful at generating
revenue. Efficiency also means that the tax should raise enough revenue to be
worthwhile.
C) Two Principles of Taxation

Taxes in the United States are based on two principles that have evolved over the
years. The Benefit Principle and the Ability-to-Pay Principle.
a. Benefit Principle – Those who benefit from government goods and services
should pay in proportion to the amount of benefits they receive.
i. Has Two Limitations – many government services provide the greatest
benefit to those who can least afford to pay for them. The other
limitation is that benefits often are hard to measure.
b. Ability-to-Pay Principle – the belief that people should be taxed according to
their ability to pay, regardless of the benefits they receive. People with higher
incomes suffer less discomfort paying taxes than people with lower incomes.
D) Types of Taxes – there are three types of taxes
a. Proportional Tax – imposes the same percentage rate of taxation on everyone,
regardless of income. Gives an average tax rate.
b. Progressive Tax – imposes a higher percentage rate of taxation on persons
with higher incomes. Marginal tax rate – increases as income increases.
c. Regressive Tax – imposes a higher percentage rate of taxation on low incomes
than on higher incomes.
Tax
Proportional
Progressive
Regressive
Hurts
Poor
Rich
Poor
Benefit
Rich
Poor
Rich
Section 2: The Federal Tax System
A) Individual Income Taxes – in 1913 the 17th Amendment to the US Constitution was
ratified, allowing Congress to levy an income tax. The first time an income tax was
levied was during the American Civil War and was ruled unconstitutional.
a. Payroll Deductions – Internal Revenue Service (IRS) – the branch of the US
Treasury Department in charge of collecting taxes.
i. Tax Return – an annual report to the IRS summarizing total income,
deductions, and the taxes withheld by employers.
b. A Progressive Income Tax – individual income tax is a progressive tax.
B) FICA Taxes – the second most important tax.
a. FICA – Federal Insurance Contributions Act levied on both employers and
employees to pay for Social Security and medicare.
b. Medicare – is a federal health-care program
c. Payroll taxes – because they are deducted from yoru payroll check.
C) Corporate Income Tax – the tax a corporation pays on its profits. The corporation is
taxed separately from individuals because the corporation is recognized as a separate
legal entity.
D) Other Federal Taxes
a. Excise Taxes – a tax on the manufacture or sale of selected items, such as
gasoline and liquor. A Luxury good is a good that rises faster than income
when income grows.
b. Estate and Gift Taxes –
i. Estate Tax – levied on the transfer of property when a person dies.
ii. Gift Tax – tax on donations of money or wealth and is paid by the
person who makes the gift.
c. Customs Duties – a charge levied on goods brought in from other countries.
Section 3: State and Local Tax Systems
A) State Government Revenue Sources
a. Intergovernmental Revenues – the largest source of state revenue – funds
collected by one level of government that are distributed to another level of
government for expenditures. Welfare, education, highways, and hospitals.
b. Taxes and Fees – sales tax is a general tax levied on consumer purchases of
nearly all products. States also have individual income taxes (Texas does
not).
B)
Local Government Revenue Sources
a. Intergovernmental Revenues
b. Property Taxes – a tax on tangible and intangible possessions such as real
estate, buildings, furniture, automobiles, farm animals, stocks, bonds, ad bank
accounts.
i. The Tax Assessor – the person who assigns value to property for tax
purposes.
C) Examining Your Paycheck
a. Payroll Withholding Statement – the summary statement attached to a
paycheck that summarizes income, tax withholding, and other deductions.
Chapter 10 Government Spending
Section 1: The Economic of Government Spending
 Government is a big business in America.
A) Government Spending in Perspective
a. Public sector is the part of the economy made up of federal, state, and local
governments. The amount of money spent in this area has increased over the
years.
i. World War II started the increase
ii. A change in public opinion that gave government a larger role in
everyday economic affairs
iii. Large Scale public works during the Depression
iv. Over time, many Americans have accepted increased government
expenditures as the inevitable consequence of progress.
b. Private Sector – the part of the economy made up of private individuals and
privately-owned businesses – should provide
B) Two Kinds of Spending
a. Goods and Services – the government buys many goods from the private
sector.
b. Transfer Payments
i. A payment for which the government receives neither goods nor
services in return. Social Security, welfare, unemployment
compensation, and aid for people with disabilities.
ii. A transfer payment one level of government makes to another is
known as a grant-in-aid.
C) Impact of Government Spending
a. Affecting Resource Allocation – government spending decisions directly
affect how resources are allocated.
b. Redistributing Income – the way in which income is allocated among families,
individuals, or other designated groups in the economy.
c. Competing With the Private Sector – when the government produces goods
and services, it often competes with the private sector.
Section 2: Federal Government Expenditures

Federal budget – an annual plan outlining proposed revenues and expenditures for the
coming year.

2/3 of the federal budget consists of mandatory spending – spending authorized by
law that continues without the need for Congress approval. Interest payments, Social
Security, and medicare.

Discretionary Spending – programs that must receive annual authorization. Military,
the Coast Guard, and welfare.
A) Establishing the Federal Budget – a Fiscal year – a 12 month financial planning
period that may or may not coincide with the calendar year.
a. Executive Formulation
i. Federal budget surplus – an excess of revenues over expenditures.
ii. Federal budget deficit – shortfall in the budget.
b. Action by the House – Appropriations bill – an act of Congress that allows
federal agencies to spend money for specific purpose.
c. Action by the Senate – may approve the bills as sent by the House, or it may
draft its own versions.
d. Final Approval – must be sent to the President for approval and signature.
B) Major Spending Categories
a. Social Security makes up the largest category of federal spending.
b. Medicaid – a joint federal-state medical insurance program for low-income
persons.
Section 3: State and Local Government Expenditures
A) Approving Spending
a. Balanced Budget Amendment – a constitutional amendment that requires that
annual spending not exceed revenues.
B) State Government Expenditures
a. The largest category of state expenditures is intergovernmental expenditures –
funds that one level of government transfers to another level for spending.
C) Local Governmental Expenditures
a. Education, utilities, hospitals, police, interest on debt, public welfare.
Section 4: Deficits, Surplus, and The National Debt
A) From the Deficit to the Debt – the federal budget has been characterized by a
remarkable amount of deficit spending – or spending in excess of revenues
collected.
a. Deficits Add to the Debt
i. Federal debt – the total amount borrowed from investors to finance the
government’s deficit spending.
ii. Balanced budget – an annual budget in which expenditures equal
revenues – the federal debt will not change.
b. How Big Is the Debt?
c. Public vs. Private Debt
i. We owe most of the federal debt to ourselves – whereas private debt is
owed to others
ii. One difference is repayment. When private citizens borrow money,
they repay the debt by a specific date. Public debt gives little thought
to eventual repayment because it simply issue new bonds and uses the
proceeds to pay off old bonds.
B) Impact of the National Debt
a. The federal debt can have a significant impact on the distribution of income
within the economy.
C) Taming the Deficit
a. Concern over the size of the federal deficit and the debt has led to a number of
attempts to control it.
Chapter 11: Money and Banking
Section 1: The Evolution of Money

Money is something we all take for granted, but without it life would be quite
different.

Barter economy – a moneyless economy that relies on trade.

There must be a “mutual coincidence of wants” – which means that two people want
exactly what the other has and are willing to trade what they have for it – it is difficult
for trade to take place.
A) Functions of Money

Money can be any substance that serves as a medium of exchange, a measure of
value, and a store of value
a. Medium of Exchange – something accepted by all parties as payment for
goods and services
b. Measure of Value – a common denominator that can be used to express worth
in terms that most individuals understand.
c. Store of Value – the property that allows purchasing power to be saved until
needed.
B) Money in Early Societies

Many things have been used as money: salt (Romans – worth your weight in salt),
bricks of tea, shells, etc.

Commodity money – money that has as alternative use as an economic good, or
commodity.

Fiat money – money by government decree – such as the tiny, metallic coins.
C) Money in Colonial America

Gunpowder, corn, tobacco, etc.
a. Paper Currency
i. State law allowed individuals to print their own paper currency.
ii. Paper money was issued to finance the Revolutionary War –
Continental Dollars
b. Specie
i. Specie – or money in the form of coins made from silver or gold – was
also used in the colonies.
ii. Coins were the most desirable form of money.
D) Origins of the Dollar
a. Pesos in America – pieces of eight. Two bits, four bits, …..
b. From “Talers” to “Dollars”
i. Ben Franklin and Alexander Hamilton decided to make the dollar the
basic monetary unit, or standard unit of currency, in the US money
system.
E) Characteristics of Money
a. Portability – money must be portable, or easily transported from one person to
another, to make the exchange of money for products easier.
b. Durability – money must last when handled and does not deteriorate.
c. Divisibility – easily divisible into smaller units
d. Limited Availability – limited supply. Money loses its value whenever there
is too much of it.
Section 2: Early Banking and Monetary Standards

Monetary Standard – the mechanism designed to keep the money supply portable,
durable, divisible, and limited in supply – helps with this task.
A) Privately Issued Bank Notes

Article 1, Section 8, of the US Constitution states that Congress shall have the power
to coin money.

Article 1, Section 10 states that No State shall coin money.
a. Growth of State Banking
i. Banks in the colonial period were allowed to issue their own paper
money
ii. State Banks receive their charter (license) to operate from a state
government.
b. Abuses in Banking
i. Most banks printed only the amount of currency they could reasonably
back with their gold and silver reserves.
c. Problems With Currency
i. Hundreds of different kinds of notes could be in circulation in any
given city.
B) The Greenback Standard
a. Greenbacks
i. In 1861 – Congress authorized the printing of demand notes. These
notes were declared legal tender – fiat currency that must be accepted
in payment of debt.
ii. They were called Greenbacks because both sides were printed with
green ink to distinguish them from the state notes already in
circulation.
iii. In 1862 – the Legal Tender Act established the United State Notes that
were not backed by gold or solver.
b. National Currency
i. The National Banking System (NBS) made up of national banks
(privately owned banks that received their operating charter from the
federal government.
ii. Paper currency of uniformed appearance that was backed by the
United States government bonds.
c. Gold Certificates
i. Paper currency backed by gold placed on deposit with the United
States Treasury
d. Silver Certificates
i. Paper currency backed by silver dollars and bullion placed on reserve
with the Treasury.
e. Treasury Coin Notes
i. Paper currency issued by the Treasury that was redeemable in both
gold and silver.
C) The Gold Standard

A monetary standard under which the basic currency unit is equal to, and can be
exchanged for, a specific amount of gold.
a. Advantages of a Gold Standard
i. People feel more secure about their money
ii. Supposed to prevent the government from printing too much money
b. Disadvantages of a Gold Standard
i. Gold stock may not grow fast enough to support a growing economy.
ii. People may suddenly decide to convert their currency into gold
iii. Price of gold is likely to change dramatically over time.
iv. There is a political risk of failure
c. Abandoning the Gold Standard
i. 1934 – Gold Reserve Act was passed during the Depression. No more
gold coins would be minted nor allowed to be owned. The United
States went off the Gold Standard with this act.
D) The Inconvertible Fiat Money Standard

A money standard under which the fiat money supply can not be converted into gold
or silver by its citizens.
a. A Managed Money Supply
i. The Federal government is responsible with the management of the
money supply.
b. Characteristics of Modern Money
i. Portable
ii. Durable
iii. Divisible
iv. Limited Availability
Section 3: The Development of Modern Banking
A) Revising the Banking System
a. 1863 – National Banking Act
b. 1907 – Panic caused US Government to look at banking system
B) The Federal Reserve System

Banking reform in 1913 established the Federal Reserve System (FED) as the
nation’s first true central bank.

A Central Bank is a bank that can lend to other banks in time of need.

The President appoints the Fed’s Board with the approval of the Senate.
a. Banking During the Great Depression
i. Run on the Bank – a rush by depositors to withdraw their funds from a
bank before it fails.
ii. Bank Holiday – a brief period during which every bank in the nation
was required to close.
b. Federal Deposit Insurance
i. Federal Deposit Insurance Corporation (FDIC) to insure customer
deposits in the event of a bank failure.
ii. Maximum of $100,000 for one person at one bank.
C) Other Depository Institutions

Commercial banks – banks that catered to the interests of business and commerce.

Demand Deposit Accounts (DDAs) – accounts whose funds could be removed by
simply writing a check without prior approval from the depository institution.
a. Savings Banks
i. Mutual Savings Bank (MSB) a depositor-owned financial organization
operated only for the benefit of its depositors.
ii. These became known as Savings Banks because they were no longer
mutually owned by depositors.
b. Savings and Loan Associations
i. S & L – a depository institution that invests the majority of its funds in
home mortgages.
c. Credit Unions
i. A nonprofit service cooperative that is owned by, and operated for, the
benefit of its members.
Chapter 12: Financial Markets
Section 1: Savings and the Financial System

Saving means the absence of spending.

Savings refers to the dollars that become available when people abstain from
consumption.
A) Saving and Capital Formation
a. Saving makes economic growth possible
B)

Financial Assets and the Financial System
Financial System – a network of savers, investors, and financial institutions that work
together to transfer savings to investors.
a. Financial Assets
i. Certificate of Deposit – a receipt showing that an investor has made an
interest-bearing loan to a bank or a government or corporate bond
b. The Circular Flow of Funds
i. Almost everyone participates in, and benefits from, the financial
system.
C) Nonbank Financial Intermediaries
a. Finance Companies
i. A firm that specializes in making loans directly to consumers and in
buying, installment contracts from merchants who sell goods on credit.
b. Life Insurance Companies
i. Although its primary purpose is to provide financial protection for
survivors of the insured, it also collects a great deal of cash.
ii. Premium – is the price the insured pays for this policy and its usually
paid monthly, quarterly, or annually for the length of the protection.
c. Mutual Fund
i. A company that sells stock in itself to individual investors and then
invests the money it receives in stocks and bonds issued by other
corporations.
d. Pension Funds
i. A regular payment intended to provide income security to someone
who has worked a certain number of years, reached a certain age, or
suffered a certain kind of injury
Section 2: Investment Strategies and Financial Assets
A) Basic Investment Considerations
a. The Risk-Return Relationship
i. The most important relationship in the market is between risk and
return
ii. Risk is a situation in which the outcome is not certain, but probabilities
for each possible outcome can be estimated.
b. Investment Objectives
i. If your goal is to save for retirement, you might want to purchase
assets that simply appreciate in value rather than generate current
income.
c. Simplicity
i. Most analyst advise investors to stay with what they know.
ii. If an investment seems too complicated, then ignore it and invest in
something else.
d. Consistency
i. Most investors invest for a long period of time.
e. 401 (k) Plans
i. 401 (k) plans are a tax deferred investment and savings plan that acts
as a personal pension fund for employees
ii. returns on a 401 (k) are especially high when the employer provides
matching funds
iii. The 401 (k) is popular because it provides a simple, consistent, and
relatively safe way for employees to save and you can take the 401 (k)
with you if you change jobs
B) Bonds as Financial Assts
a. Bond Components
i. A Bond has three main components
1. Coupon – the stated interest on the debt
2. Maturity – the life of the bond
3. Par value – the principal or the total amount that must be repaid
to the lender at maturity
C) Financial Assets and Their Characteristics
a. Certificates of Deposit
i. Are the most common forms of investment available.
ii. Low as $100 investment
b. Corporate Bonds
i. Low as $1000 investment
ii. Most start at $10,000
c. Municipal Bonds
i. Are bonds issued by state and local governments.
ii. States issue bonds to finance highways, state buildings, and some
public works.
iii. They are safe because state and local governments do not go out of
business.
iv. Tax-exempt – meaning there is no federal tax n the interest.
d. Government Savings Bonds
i. Are low-denomination, nontransferable bonds issued by the United
States government, usually through payroll-savings plans.
ii. Savings bonds are attractive because they are easy to obtain and there
is virtually no risk of default.
e. Treasury Notes and Bonds
i. $1000 to $5000
ii. Maturities ranging from more than 10 years to 30 years
f. Treasury Bills
i. Also known as a T-bill, short-term obligation with a maturity of 13,
26, or 52 weeks.
ii. Minimum denomination of $10,000
g. Individual Retirement Account
i. IRAs – are long-term, tax-sheltered time deposits that an employee can
set up as part of a retirement plan.
ii. Roth IRAs – contributions are made after taxes so that no taxes are
taken out at maturity.
D) Markets for Financial Assets
a. Capital Markets
i. Markets where money is loaned for more than one year.
b. Money Markets
i. Markets where money is loaned for periods of less than one year.
c. Primary Markets
i. Market where only the original issuer can repurchase or redeem a
financial asset.
d. Secondary Markets
i. Market in which existing financial assets can be resold to new owners.
Section 3: Investing in Equities, Futures, and Options
A) Market Efficiency
a. Stockbroker – a person who buys or sells equities for clients. The broker
arranges to have the stocks purchased at a stock exchange.
B) Organized Stock Exchange
a. The New York Stock Exchange
i. The oldest, largest, and most prestigious of the organized exchanges in
the US.
ii. NYSE
b. The American Stock Exchange
i. AMEX
C) Measures of Stock Performance
a. Dow-Jones Industrial Average
i. Most popular measure of stock market performances.
b. Bull vs. Bear Market
i. Bull Market – A “strong” market with the prices moving up for several
months or years in a row.
ii. Bear Market – A “mean” market with the prices of equities moving
sharply down for several months or years in a row.