Chapter 9
THE MIXED ECONOMY OF THE UNITED STATES
Chapter in a Nutshell
1. The way income is divided among members of society is known as the distribution of income.
There are two approaches for analyzing income distribution. The functional distribution of
income shows the shares of a nation's income accruing to land, labor, capital and
entrepreneurship as rent, wages, interest, and profits. The personal distribution of income
shows the share of income received by poor, middle-income, and wealthy families.
2. Household income flows into consumption expenditures, taxes, and savings. Consumption
expenditures are made on durable goods, non-durable goods, and services. The United States
is a service-oriented economy with over half of household consumption expenditures used for
services in 1994.
3. A business firm can be organized in one of three ways: as a sole proprietorship, a partnership,
or a corporation. Although sole proprietorships are numerically dominant in the United States,
corporations account for the largest share of total business sales.
4. Government expenditures include federal, state, and local government purchases of goods and
services and also transfer payments. Transfer payments have been the main source of the
increasing size of government in the past four decades.
5. Social Security is the largest retirement and disability program in the United States. It is a pay
as you go system financed by payroll taxes levied on employees and their employers. Social
Security is mandatory for most workers who must belong whether they like it or not.
Beginning in the 1970s, the Social Security trust funds began to decline and are projected to
go bankrupt in 2029. Social Security's financial problems largely stem from liberal benefit
increases and a declining number of workers paying Social Security taxes compared to an
increasing number of beneficiaries.
6. For the U.S. government, the personal income tax is the major source of revenue while income
transfer programs—such as Social Security and Medicare—are the major expenditure. State
and local governments rely primarily on sales taxes, excise taxes, and property taxes as
revenue raisers while education is the major expenditure.
7. The U.S. tax system is founded upon the benefits-received principle and the ability to pay
principle. Taxes fit into one of three types of systems: proportional taxation, progressive
taxation, and regressive taxation. The federal tax system is somewhat progressive while state
and local tax systems tend to be regressive.
8. Tax loopholes—including exemptions, deductions, and credits—decrease the progressivity of
the federal income tax. Critics of the federal income tax contend that it favors the rich who
can shelter much of their income by using tax loopholes. Proposed reforms of the federal tax
system include the flat-rate income tax and the value-added tax.
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Chapter 9: The Mixed Economy of the Unites States
89
Chapter Objectives
After reading this chapter, you should be able to:
1. Distinguish between the functional distribution of income and personal distribution of income.
2. Explain why some people earn more income than others.
3. Assess the advantages and disadvantages of a sole proprietorship, a partnership, and a
corporation.
4. Identify the major sources of revenue and expenditures of the federal government and also of
state and local governments.
5. Evaluate various proposals for reforming the Social Security system.
6. Identify the principles upon which the U.S. tax system is founded.
7. Explain how tax loopholes undermine the progressivity of the federal income tax.
8. Identify the advantages and disadvantages of a flat-rate income tax.
Knowledge Check
Key Concept Quiz
1. mixed economy
_____ a. consists of both the private and public sectors
2. functional distribution of
income
_____ b. specifies that taxes should be paid in proportion to
the benefits received
3. personal distribution of
income
_____ c. something corporations are subject to
4. sole proprietorship
_____ d. the fashion in which income is shared by
individual households
5. limited liability
_____ e. an advantage for the stockholders of a corporation
6. double taxation
_____ f. shows the shares of a nation’s income accruing to
the factors of production
7. transfer payments
8. cost-of-living adjustment
9. benefits-received
principle
10. ability-to-pay principle
11. marginal tax rate
12. value–added tax
_____ g. fraction of additional income paid in taxes
_____ h. a firm owned and operated by one individual
_____ i. is collected at the various stages of production
_____ j. is founded on the notion that people with greater
income and wealth should be taxed at a higher rate
_____ k. provide a safety net of income security for the poor
and needy
_____ l. periodic adjustments made to keep pace with
inflation
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Chapter 9: The Mixed Economy of the Unites States
Multiple Choice Questions
1. The U.S. economy is
a.
b.
c.
d.
run by the government
pure capitalist economy
a command economy
a mixed economy
2. The functional distribution of income shows the shares of a nation’s income accruing to
a.
b.
c.
d.
land, labor, capital, entrepreneurship
the richest 25 percent
the poorest 25 percent
all of the above
3. Some of the most important determinants of income differences are
a.
b.
c.
d.
age and discrimination
differences in production resources and inheritance
investment in human capital
all of the above
4. A business firm may be organized in all of the following ways except
a.
b.
c.
d.
a sole proprietorship
a partnership
a corporation
a merger
5. The greatest disadvantage of a sole proprietorship is
a.
b.
c.
d.
unlimited liability
low profits
small size
limited liability
6. Corporations have the following drawbacks except
a. they are subject to double taxation
b. they suffer from separation of control
c. they may increase the cost of doing business and decrease the dividends of
stockholders
d. they charge monopoly prices
7. Government expenditures consist of
a.
b.
c.
d.
government purchases and transfer payments
government purchases only
transfer payments only
welfare payments only
Chapter 9: The Mixed Economy of the Unites States
8. The major governmental transfer payments have included all of the following except
a.
b.
c.
d.
unemployment compensation
Medicaid
agricultural assistance
Social Security
9. All of the following are true of the Social Security Trust Funds except
a. they are accounts located at the U.S. Treasury
b. they represent a promise (IOU) from the government
c. they are pledges to obtain resources in the future equal to the value of the trust-fund
accounts
d. they hold money to pay benefits
10. All of the following is being considered as options for “saving” Social Security except
a.
b.
c.
d.
decrease the income cap
adopt means testing
raise the retirement age
fully tax Social Security benefits
11. One of the ways in which the federal government finances its debt involves
a.
b.
c.
d.
issuing stock sold in stock markets all over the world
charging for licenses
borrowing from foreign banks
selling securities to households, financial institutions and businesses
12. A toll charged on a bridge in Key West, Florida to pay for the bridge follows
a.
b.
c.
d.
the benefits-received principle
the ability to pay principle
the fair tax principle
the redistribution of income principle
13. A tax system is called regressive when as income rises
a.
b.
c.
d.
the average tax rate and marginal tax rate increase
the average tax rate and marginal tax rate decrease
the average and marginal tax rate remains constant
the marginal tax rate increases and the average tax rate decreases
14. Under a proportional tax system
a.
b.
c.
d.
as income increases the average tax rate remains constant
income increases the marginal tax rate remains constant
is a flat tax system
all of the above
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Chapter 9: The Mixed Economy of the Unites States
15. Most economists argue that when federal, state and local taxes are combined, the overall tax
system in the U.S. is roughly
a.
b.
c.
d.
proportional
regressive
progressive
unfair
16. The largest expenditure item of the federal government is
a.
b.
c.
d.
national defense
income transfer programs
education
interest on the public debt
17. If the income tax liability of Mary Smith increases from $2,000 to $3,000 as her income
increases from $20,000 to $25,000, her marginal tax rate is
a.
b.
c.
d.
10 percent
13 percent
20 percent
25 percent
18. A tax is progressive when it
a.
b.
c.
d.
emphasizes the benefit-received principle instead of the ability-to-pay principle
takes more dollars from the rich than the poor
takes a larger fraction of income as income increases
is forward looking and enhances the growth of the economy
19. Compared to corporations, proprietorships and partnerships have the advantage of
a.
b.
c.
d.
flexibility and simplicity
unlimited liability
limited liability
ease of raising funds for investment
20. Which of the following is subject to Adouble taxation@ by corporations?
a.
b.
c.
d.
salaries and wages paid by the corporation
rental income received by the corporation
interest income received by the corporation
dividends paid by the corporation
21. The personal distribution of income indicates the share of national income
a.
b.
c.
d.
received by one-fifth of families
being spent on durable goods, nondurable goods, and services
interest income received by the corporation
dividends paid by the corporation
Chapter 9: The Mixed Economy of the Unites States
93
22. About what percent of U.S. household income is devoted to personal consumption
expenditures?
a.
b.
c.
d.
80-85%
60-65%
45-50%
30-35%
23. The largest share of U.S. personal consumption expenditures consists of
a. durable goods
b. nondurable goods
c. services
d.
automobiles
24. Concerning U.S. business firms, _____ are numerically the most dominant while
_____account for the greatest share of business receipts
a.
b.
c.
d.
partnerships, proprietorships
proprietorships, corporations
corporations, partnerships
partnerships, corporations
25. The U.S. system of social security is characterized by all of the following except
a.
b.
c.
d.
is a pay as you go system financed by payroll taxes
provides cost-of-living adjustments for beneficiaries
allows workers to place all of their payroll taxes into personal retirement accounts
provides retirement benefits and health insurance for the public
26. The U.S. social security tax
a.
b.
c.
d.
is entirely a progressive tax
is entirely a regressive tax
is entirely a proportional tax
has both proportional and regressive features
27. In its purest form a ____ would junk the existing array of different tax rates on personal
income and replace them with a single tax
a.
b.
c.
d.
progressive tax
flat-rate tax
regressive tax
national sales tax
True-False Questions
1.
T
F
The United States is a manufacturing-oriented economy with over half of
the household consumption expenditures used for goods.
2.
T
F
Government expenditures include federal and state but not local
government purchases of goods and services.
3.
T
F
Transfer payments are not included in government expenditures.
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Chapter 9: The Mixed Economy of the Unites States
4.
T
F
Increase in defense expenditures has been the dominant source of the
increasing size of government during the past four decades.
5.
T
F
Social Security is projected to go bankrupt in 2031.
6.
T
F
Sole proprietorships are the numerically dominant form of business in
the United States.
7.
T
F
Social Security is a pay-as-you-go system financed by payroll taxes
levied only on employers.
8.
T
F
Social Security is not a mandatory system.
9.
T
F
The only approach for analyzing income distribution involves the
analysis of the personal distribution of income.
10.
T
F
Corporations account for the largest share of total business sales.
11.
T
F
Household income flows into consumption and taxes.
12.
T
F
The tax loopholes make the federal income tax more progressive.
13.
T
F
VAT is just like a national sales tax.
14.
T
F
VAT is a tax on consumption.
15.
T
F
A flat-rate income tax is progressive.
16.
T
F
Excise taxes are proportional.
17.
T
F
Medicare is the major state expenditure.
18.
T
F
Education and Social Security are the major expenditures of the federal
government.
19.
T
F
The gasoline tax is consistent with the benefits-received principle.
20.
T
F
The Social Security Trust Fund is the ultimate risk pool.
21.
T
F
Proposed reforms of the federal personal income tax include a flat-rate
income tax, a valued-added tax, and a national sales tax.
22.
T
F
The federal income tax system is highly regressive and the state and local
tax system is somewhat progressive.
23.
T
F
For state and local governments, the largest source of revenue is the
personal income tax.
24.
T
F
National defense spending comprises the largest share of expenditures
for the U.S. government.
25.
T
F
Sales taxes of state governments tend to be progressive.
26.
T
F
Social security is the largest retirement and disability program in the
United States.
F
Durable goods constitute the largest source of personal consumption
expenditures for Americans.
27.
T
Chapter 9: The Mixed Economy of the Unites States
Application Questions
1. In Flatland an income tax rate of 20 percent prevails. Use the table below to answer the
questions that follow.
Year
Income
(billions of
dollars)
1999
25.000
2000
26.250
Tax
(billions of
dollars)
a. What are the total tax payments in 1999?
b. What are the total tax payments in 2000?
c. What is the marginal tax rate?
2. Use the table below to answer the questions that follow.
Year
Income
(billions of
dollars)
Tax
(billions of
dollars)
1998
20.000
4.000
1999
25.000
5.000
2000
26.250
5.625
a. What is the average tax rate in 1999?
b. What is the average tax rate in 2000?
c. What would you call this tax system?
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Chapter 9: The Mixed Economy of the Unites States
d. Does the marginal tax rate change between 1998 and 2000? How?
e. What is the essential difference between the two tax systems described in questions 1
and 2?
f.
How would you characterize the difference between a regressive tax system and the
one described in this question?
g. Is our Social Security tax system similar to the one described in this question?
h. Is the federal income tax similar to the one described in this question?
Answers to Knowledge Check Questions
Key Concept Answers
1. a
4. h
2. f
5. e
3. d
6. c
7. k
8. l
9. b
10.
11.
12.
Multiple Choice Answers
1. d
6. d
2. a
7. a
3. d
8. d
4. d
9. d
5. a
10. a
11.
12.
13.
14.
15.
d
a
b
d
a
16.
17.
18.
19.
20.
b
c
c
a
d
21.
22.
23.
24.
25.
a
a
c
b
c
26. d
27. b
True-False Answers
1. F
6. T
2. F
7. F
3. F
8. F
4. F
9. F
5. F
10. T
11.
12.
13.
14.
15.
F
F
T
T
F
16.
17.
18.
19.
20.
F
F
F
T
T
21.
22.
23.
24.
25.
T
F
F
F
F
26. T
27. F
j
g
i
Chapter 9: The Mixed Economy of the Unites States
97
Application Question Answers
1. a. $5 billion
b.
$5.25 billion
c.
The marginal tax rate is 20 percent.
2. a.
The average tax rate is 20 percent.
b.
The average tax rate is 21 percent.
c.
A progressive tax system.
d.
Yes. Between 1998 and 1999 the marginal tax rate is 20 percent. However, between
1999 and 2000, the marginal tax rate is a whopping 50 percent!
e.
In Flatland, the average and marginal tax rates remain constant. In Liberland, the
marginal tax rates increase, thus increasing the average tax rates.
f.
In a regressive tax system, the marginal tax rates decline as income increases. Hence, as
income increases, the average tax rates decline.
g.
No. The Social Security tax system in the United States is regressive.
h.
Yes. The federal income tax system is progressive.