Chapter Focus
Section 1 Raising Money
Section 2 Preparing the Federal
Budget
Section 3 Managing the Economy
Chapter Assessment
Chapter Objectives
•
Raising Money Identify the kinds of taxes and
the methods of borrowing the government uses
to raise money.
•
Preparing the Federal Budget Describe the
roles of the executive and legislative branches
in the preparation of the federal budget.
•
Managing the Economy Explain the influence
of fiscal and monetary policies on the economy.
Raising Money
Key Terms
taxes, taxable income, dependent, withholding,
securities, national debt
Find Out
• How does the income tax compare with other
sources of federal revenue in terms of the
amount collected?
• How does the federal government use tax laws to
affect economic decisions?
Raising Money
Understanding Concepts
Civic Participation How are income taxes
collected from citizens of the United States?
Section Objective
Identify the kinds of taxes and the methods of
borrowing the government uses to raise money.
Representative Dick Armey (R-Texas)
keeps his constituents informed on issues
through his Web page. Among other
things, the page features a daily update of
the amount of the national debt. On
October 15, 2000, the debt equaled
$5,653,997,843,075.88. To pay off the
debt, each American would have to
contribute $21,152.21.The interest on the
national debt is one of the largest
expenses of the federal government.
I. Taxes as a Source of Revenue
(pages 555–558)
A. Individual income taxes are the
government’s largest source of revenue.
1) The income tax is progressive, that is, it
is based on ability to pay.
2) April 15 each year is the deadline for
filing income tax returns.
3) The Internal Revenue Service (IRS)
collects taxes during the year through its
regional centers.
B. Corporations, too, pay income taxes
on income they earn beyond expenses
and deductions.
I. Taxes as a Source of Revenue
(pages 555–558)
C. The federal government collects social
insurance taxes paid equally by employees
and employers to pay for Social Security
and Medicare.
D. Excise taxes are federal taxes on the
manufacture, transportation, sale, and
consumption of goods like gasoline, tires, oil,
liquor, and cigarettes, and the performance
of services.
E. Customs duties are levied on goods
imported into the United States.
F. The federal government collects an estate
tax on the property and money above a set
amount when someone dies.
I. Taxes as a Source of Revenue
(pages 555–558)
I. Taxes as a Source of Revenue
(pages 555–558)
Do you agree or disagree with the policy that
exempts colleges, labor unions, churches,
and other nonprofit groups from paying
income taxes? Explain.
Students should weigh the value of nonprofit
organizations against loss of revenue.
II. Taxes and the Economy (pages 558–559)
A. U.S. tax laws are complex and filled with
special provisions.
B. Tax exemptions, or loopholes, favor certain
groups and encourage activities such as
oil exploration.
C. The Tax Reform Act of 1986 reduced many
tax exemptions, tax credits, and tax shelters,
and the number of tax brackets.
D. The federal government today provides tax
credits to people in lower income brackets.
II. Taxes and the Economy (pages 558–559)
What are some benefits and losses
associated with the tax credits policy for
people with lower incomes?
Answers will vary. Tax credits are a way of
shifting the tax burden to those most able to pay.
III. Borrowing for Revenue (page 559)
A. In addition to collecting taxes, the federal
government borrows to raise money by
selling federal securities, such as bonds,
notes, and certificates, on which it
pays interest.
B. The accumulated moneys the government
borrows is the national debt.
III. Borrowing for Revenue (page 559)
Why does the federal government sell
securities to individuals, corporations,
and other institutions, and how does this
affect the national debt?
The government sells securities to raise
revenues. This is a form of borrowing that adds
to the national debt.
Checking for Understanding
1. Main Idea Use a graphic organizer like the one
below to show the steps in collecting federal
income tax.
Employers withhold estimated taxes from
workers’ pay and send the money to the IRS;
self-employed people pay an estimated tax 4
times per year; by April 15 the following year,
each taxpayer must file a return and send any
amount still owed.
Checking for Understanding
Match the term with the correct definition.
___
F taxes
A. one who depends primarily on another
person for basic needs
___
C taxable
income
B. financial instruments that are sold as a
means of borrowing money with a
promise to repay the buyer with interest
after a specific time period
___
A dependent
___
D withholding
___
B securities
___
E national
debt
C. the total income of an individual minus
certain deductions and personal
exemptions
D. the money an employer withholds from
workers’ wages as payment of
anticipated income tax
E. the total amount of money the
government owes at any given time
F. money that people and businesses pay
to support the activities of the
government
Checking for Understanding
3. Identify progressive tax, IRS, social insurance
taxes, regressive tax, tax loophole.
A progressive tax is a tax based on a taxpayer’s ability
to pay.
The IRS, or Internal Revenue Service, is the bureau of
the United States Treasury Department responsible for
collecting taxes.
Social insurance taxes are taxes collected to pay for
major social programs such as Social Security, Medicare,
and unemployment compensation.
A regressive tax is a tax in which people with lower
incomes pay a larger portion of their income.
A tax loophole is an exemption from taxes.
Checking for Understanding
4. What is the federal government’s biggest single
source of tax revenue?
The federal government’s biggest single source
of tax revenue is the individual income tax.
Critical Thinking
5. Identifying Alternatives Why does the
government raise most of its revenues through
taxing rather than borrowing?
Although taxes are unpopular, borrowing costs
the government a huge amount of interest, adds
to the national debt, and threatens the nation’s
economic security.
Civic Participation Obtain a paycheck
stub—yours or a family member’s. Note
the categories and amounts of money
deducted for city and state taxes, FICA,
and Social Security. Create a graph that
shows the percentage of the earned
wages deducted in each category.
Preparing the Federal Budget
Key Terms
fiscal year, uncontrollables, entitlement,
incrementalism
Find Out
• How do the executive and legislative branches
work together to produce an annual budget for
the federal government?
• Why is it so difficult for the federal government to
reduce spending or raise taxes in order to
balance the budget?
Preparing the Federal Budget
Understanding Concepts
Public Policy What factors prevent the budget
from changing very much from year to year?
Section Objective
Describe the roles of the executive and legislative
branches in the preparation of the federal budget.
In August 1997, Congress and the
president agreed to enact a balanced
federal budget for the first time in 30 years.
In reaching this historic agreement,
President Clinton and the Republicancontrolled Congress cut individual income
taxes by $94 billion and pledged to reduce
the federal deficit by $182 billion over the
next 5 years.
I. Drawing Up the President’s Budget
(pages 560–562)
A. Since 1921 the president has been
responsible for preparing the budget.
B. The Office of Management and Budget
(OMB) collects spending requests from each
federal agency and analyzes the nation’s
economic situation. The president, the OMB
director, the secretary of the treasury, and
the president’s Council of Economic
Advisors (CEA) discuss how the proposed
budget may affect the administration’s
general policies and goals.
I. Drawing Up the President’s Budget
(pages 560–562)
C. The White House returns guidelines to the
federal agencies to help them prepare their
final budgets.
D. Before the final budget is presented to
Congress, the OMB submits a complete
budget to the president for final review
and approval.
E. About 70 percent of spending in the federal
budget is uncontrollables, or expenditures
required by law or resulting from previous
commitments, such as Social Security,
government pensions, Medicare, veterans’
benefits and interest on the national debt.
I. Drawing Up the President’s Budget
(pages 560–562)
I. Drawing Up the President’s Budget
(pages 560–562)
How do the OMB, the CEA, and the
Department of the Treasury work with the
president in preparing the federal budget
each year?
OMB: Gives first set of figures to the president.
CEA and Treasury: Make decisions on the
effect of budget decisions on policy goals.
II. Congressional Budget Action (pages 562–564)
A. The Constitution requires that Congress
approve all federal spending; only Congress
has the power to raise revenue and pass
appropriations.
B. Congress can revise the president’s budget,
and key lawmakers must often negotiate
with the president about budget proposals.
II. Congressional Budget Action (pages 562–564)
C. The Congressional Budget Act of 1974 set up
House and Senate Budget Committees and
the Congressional Budget Office (CBO) to
centralize and evaluate the federal budget for
Congress.
D. The Gramm-Rudman-Hollings Act of 1985
aimed to force the president and Congress to
work together to reduce the huge federal
budget deficits.
II. Congressional Budget Action (pages 562–564)
E. Congress 1) reviews the president’s budget
proposals, 2) reconciles differences between
the House and Senate taxing and spending
plans, and 3) carries out the procedures in
the Gramm-Rudman-Hollings Act.
F. The Budgetary Enforcement Act (BEA) of
1990 divided the budget into domestic policy,
defense, and international affairs, and said
any spending that exceeded the budgeted
limit in any area would come out in the next
year’s funding for that area.
II. Congressional Budget Action (pages 562–564)
In what ways are the conflicts over the
budget between the president and
Congress beneficial and troublesome
for taxpayers?
Beneficial: Negotiated budget is more
carefully planned.
Troublesome: Impasse can delay programs
or shut down government.
III. Incremental Budget Making (page 564)
A. The federal budget-making process is based
on incrementalism.
B. Incrementalism means that federal agencies
usually can assume they will get at least the
same amount of money they received in the
previous year.
III. Incremental Budget Making (page 564)
For which federal agencies would you like
to see the budget increased or
decreased? Explain.
Answers will vary. Students may list budget
priorities. They should support their choices
with logical reasons.
Checking for Understanding
1. Main Idea Use a graphic organizer like the one
below to show how the budget process is
affected if Congress and the president are from
different political parties.
Cause—president and Congress are from
different parties;
Effect—budget is slowed due to the need
for compromise
Checking for Understanding
2. Define fiscal year, uncontrollables, entitlement,
incrementalism.
A fiscal year is a 12-month accounting period.
Uncontrollables are government expenditures
required by law or resulting from previous
budgetary commitments.
An entitlement is a required government
expenditure that continues from one year to
the next.
Incrementalism is the term used to explain that
the total budget changes little from year to year.
Checking for Understanding
3. Identify Office of Management and Budget,
Congressional Budget Office.
The Office of Management and Budget, or
OMB, is responsible for the actual day-to-day
preparation of the federal budget.
The Congressional Budget Office, or CBO,
is responsible for carefully evaluating the
overall federal budget for Congress and
acting as a counterbalance to the OMB in
the executive branch.
Checking for Understanding
4. Identify four entitlements that are a part of the
federal budget.
Any four: Social Security, pensions for retired
government employees, Medicare, Medicaid,
veterans’ benefits
Critical Thinking
5. Expressing Problems Clearly Why does the
federal government find it difficult to raise taxes
or reduce spending to balance the budget?
People do not want to pay more taxes, and
the budget contains about 70 percent
uncontrollables or entitlements.
Public Policy Imagine that you are a
part of a presidential committee set up to
decide the spending priorities for next
year’s government budget. Your job is to
list the four top areas that you think
should have the greatest share of the
budget. Prepare a supporting argument
for the four areas you have chosen.
Managing the Economy
Key Terms
fiscal policy, monetary policy, gross national
product (GNP), discount rate, reserve requirement,
open-market operations
Find Out
• What is the difference between fiscal policy and
monetary policy?
• What are the four major categories of federal
government spending?
Managing the Economy
Understanding Concepts
Public Policy Why must the Fed operate free of
pressures from Congress or the president?
Section Objective
Explain the influence of fiscal and monetary policies
on the economy.
The Federal Reserve Board (the Fed) plays a
key role in the nation’s economy. The Fed
determines the interest rates member banks pay
to borrow money. When the chairman of the
Fed’s Board of Governors testifies before a
congressional committee, the stock market
sometimes overreacts. On October 27, 1997,
not long after Chairman Alan Greenspan
suggested that stock prices might be getting too
high, the stock market plunged more than 554
points. Even though the market soon recovered
this loss, the experience revealed how closely
investors pay attention to the words and actions
of the Fed.
I. Where the Money Goes (pages 566–567)
A. Most of the federal government’s annual $2
trillion in spending goes to direct benefits for
individuals, national defense, discretionary
spending, and interest on the national debt.
B. Spending for Social Security, social-welfare,
and health-care programs is one of the
biggest items in the federal budget.
C. Spending for defense has increased since
2000 after decreasing during the 1990s.
D. Federal grants to state and local
governments help to pay for public housing,
road repairs, school lunch programs, flood
insurance, and other services.
I. Where the Money Goes (pages 566–567)
I. Where the Money Goes (pages 566–567)
Why do you think spending for national
defense declined following the end of the
Cold War?
National security needs were changing as the
major threat to national security was gone.
II. Fiscal and Monetary Policy (pages 567–568)
A. Beginning with the Great Depression of
the 1930s, the federal government’s role
in managing the nation’s economy
has expanded.
B. The federal government influences the
direction of the nation’s economy by its
fiscal policy.
C. The government also uses monetary policy
to influence the direction of the economy.
II. Fiscal and Monetary Policy (pages 567–568)
II. Fiscal and Monetary Policy (pages 567–568)
What tools does the federal government
use to influence and manage the
nation’s economy?
Fiscal and monetary policy.
III. The Federal Reserve System
(pages 568–570)
A. The Federal Reserve System’s 12 Federal
Reserve Districts make up the central
banking system of the United States.
B. A seven-member Board of Governors, which
supervises the Fed, is appointed to four-year
terms by the president but is independent of
both Congress and the president.
C. The Board of Governors supervises the
operations of the Federal Reserve Banks
and determines the money and credit
policies of the nation.
III. The Federal Reserve System
(pages 568–570)
D. The Board of Governors 1) fixes the discount
rate, 2) raises or lowers the reserve
requirement, and 3) puts money into the
economy through open market operations.
III. The Federal Reserve System
(pages 568–570)
How does the Board of Governors of the
Federal Reserve System carry out its
duties to determine the general money
and credit policies of the United States?
Changing the discount rate and the
reserve requirement; buying securities on
the open market.
Checking for Understanding
1. Main Idea Use a graphic organizer like the one
below to compare recent federal grants with
those in the 1980s.
1980s—number of grants for infrastructure
investment declined;
Recently—grants for public welfare
programs increased
Checking for Understanding
Match the term with the correct definition.
___
E monetary policy
A. the interest rate the Federal
Reserve System charges member
banks for loans
___
D gross national
product
B. a government’s use of spending
and taxation to influence the
economy
___
B fiscal policy
___
A discount rate
___
C reserve
requirement
C. the percentage of money member
banks must keep in Federal
Reserve Banks as a reserve
against their deposits.
D. the sum of all goods and services
produced in a nation in a year
E. a government’s control of the
supply of money and credit to
influence the economy
Checking for Understanding
3. Identify Federal Reserve System, Board
of Governors.
The Federal Reserve System is the central
banking system of the United States.
The Board of Governors supervises the
entire Federal Reserve System and
determines the general money and credit
policies of the United States.
Checking for Understanding
4. Analyze why the federal government adopted
policies that created a huge debt.
Increasing government spending provides
social programs that help people, puts more
people to work, and increases economic
activity; reducing taxes gives consumers and
investors more purchasing power; allowing the
budget deficit to grow as the gross national
product grew maintained a fairly stable debt as
a percentage of the GNP.
Critical Thinking
5. Identifying Alternatives What methods could
the federal government use to stimulate the
economy during a time when people were
opposed to deficit spending?
The government would have to rely on
monetary rather than fiscal policy. The Fed
could lower the discount rate, lower the banks’
reserve requirement, or expand credit through
open-market operations.
Public Policy Research several back
issues of The Wall Street Journal or
selections from the Readers’ Guide to
Periodical Literature to analyze Federal
Reserve Board decisions that affect the
economy. Create a poster of headline
captions showing the Fed’s actions.
Reviewing Key Terms
Insert the terms below into the following paragraph to
describe how the federal government regulates the economy.
Each term should be used only once.
withholding
national debt
taxable income
fiscal policy
monetary policy
entitlements
securities
taxes
incrementalism
GNP
fiscal year
uncontrollables
Reviewing Key Terms
The federal government collects
more than $1 trillion in (1) each
year. Through (2) wage earners
pay taxes on their (3) during the
year. The government’s (4) begins
on October 1. Because of (5) such
as (6) in the budget, government
spending often exceeds revenue,
which enlarges the (7). Some
economists are not alarmed
because deficits are only about 5
percent of the (8). Others would
like to see changes in (9) to control
spending or raise taxes. By its (10)
the Fed may stimulate economic
growth to relieve some of these
concerns.
1. taxes
2. withholding
3. taxable income
4. fiscal year
5. uncontrollables
6. entitlements
7. national debt
8. GNP
9. fiscal policy
10. monetary policy
Recalling Facts
1. What is the deadline for filing individual income
tax returns?
April 15 is the deadline for filing individual
income tax returns.
2. Identify three institutions that are exempt from
the federal income tax.
Nonprofit organizations such as churches,
colleges, and labor unions are exempt from
federal income tax. Students may list any three.
Recalling Facts
3. What are three responsibilities of the Internal
Revenue Service?
Three responsibilities of the IRS are to collect
taxes, check tax returns, and investigate
suspected criminal tax law violations.
4. What are four types of taxes that the federal
government collects?
Four types of taxes collected by the federal
government are income taxes, excise taxes,
customs duties, and estate and gift taxes.
Recalling Facts
5. What executive agency is charged with
preparing the federal budget?
The Office of Management and Budget (OMB)
is responsible for preparing the federal budget.
6. Why are federal securities such as bonds
popular with investors?
They are safe, and interest on some is
tax exempt.
Recalling Facts
7. What is the goal of the Gramm-RudmanHollings Act?
The goal is to force the president and
Congress to work together to reduce federal
budget deficits.
8. What factors make it difficult for Congress to
cut spending?
Much of the budget consists of uncontrollables
such as entitlements and interest on the
national debt; each special-interest group wants
the cuts in someone else’s area.
Recalling Facts
9. Identify state and local uses of
intergovernmental revenues.
State and local uses of intergovernmental
revenues include road repair, public housing,
police equipment and training, school lunches,
flood insurance, mental health services, public
welfare programs, and so on.
Understanding Concepts
1. Public Policy Why has the United States been
unable to balance the national budget most of
the time beginning in the 1930s?
The United States has been unable to balance
the national budget because of uncontrollables,
such as entitlements and interest on the
national debt; because of disagreements
between the president and Congress on
budgetary priorities; because of recessions; and
because of incremental budget making and
pressure from interest groups to maintain
federal spending and programs.
Understanding Concepts
2. Public Policy What kinds of banks are
members of the Federal Reserve System?
All the large, important banks in the nation are
members of the Federal Reserve System.
Critical Thinking
1. Making Generalizations Why would business
groups support protective tariffs?
Business groups support protective tariffs
because they raise the price of foreign goods,
making them less competitive compared to
American goods on the domestic market.
Critical Thinking
2. Analyzing Information Why must the Federal
Reserve Board of Governors operate free of
pressure from the president or Congress?
The Federal Reserve Board of Governors must
operate free of pressure so that it can make
decisions based on sound monetary policy
rather than political pressures.
Critical Thinking
3. Identifying Alternatives Use a graphic
organizer like the one below to show two
measures the federal government could take if
the national debt seemed to be growing too fast.
increase taxes, reduce spending
Interpreting Political Cartoons Activity
1. What is this man doing?
He is mailing his annual income tax return.
Interpreting Political Cartoons Activity
2. How does he seem to feel about this?
He is not happy; he does not like paying taxes.
Interpreting Political Cartoons Activity
3. Do you think this man’s feelings are
representative of the general feeling of
taxpayers? Explain.
Possible answer: Yes, most Americans dislike
paying taxes and do not enjoy filling out their
income tax returns, although the government
does provide services in return for the tax money.
One nontax source of revenue for the
federal government is seigniorage
(seignorage). What is that?
profit on the minting of coins
1) corporate taxes in 1950;
employment taxes in 2000
2) consistently
decreasing after 1950
3) Answers will vary.
3) United States and Russia
1) Kuwait; United States
2) U.S. has larger deficit, but Nigeria’s deficit
as a percent of its GDP is much larger
1) Answers will vary.
3) Answers will vary.
2) No; because if the Budget Bureau made any reductions an agency
might receive less than the needed amount
Watching Current Events Read newspapers and
magazines for articles on topics discussed in the
chapter, such as the IRS, the federal budget, the
Federal Reserve, tax reform, or defense spending.
Choose five articles and summarize the main
points. Then choose one issue and write a position
statement or letter to the editor about the issue.
In the past few years the federal government’s
annual expenses have exceeded $1 trillion. If you
were able to spend $1 million every day, you would
need nearly 3,000 years to spend $1 trillion.
More About Government Benefits Tax money
also goes to support parks and monuments, school
breakfast and lunch programs, disaster relief, the
space program, and many, many other things.
Fiscal comes from a Latin word meaning treasury
or basket.
A Taxing Situation
Everyone has to pay federal income tax. However,
not everyone has to pay state income tax. Seven
states do not tax their residents: Alaska, Florida,
Nevada, South Dakota, Texas, Washington, and
Wyoming. In New Hampshire and Tennessee a state
tax is imposed only on dividend and interest income.
Most states that do have an income tax use a
graduated scale, much like the federal tax. Six states,
on the other hand, have a flat rate, so everyone pays
the same percentage: Colorado, Illinois, Indiana,
Massachusetts, Michigan, and Pennsylvania.
SETTING UP THE DEBATE Work in small groups
to learn more about the various alternatives to the
current income tax and present your findings to the
class. Then prepare statements supporting or
opposing the current tax. You should include a
discussion of the alternatives in your statements.
CONCLUDING THE DEBATE Discuss the
presentations and the vote. What points did you
think were most persuasive? Did you change your
mind after the presentations? Why?
The Principles of Free Enterprise Since the
1930s, the government has taken an increasing
role in the nation’s economy. How large a role
should the government play in the economy? In the
modified free-enterprise system in the United
States, control of the economy is divided between
the government and the private sector. Debate the
following questions: How does the use of fiscal
and monetary policy conflict with the principles
of the free-enterprise system? Under what
circumstances should the government interfere
in the economy?
Filling Out Tax Returns Obtain copies of income
tax forms from the local post office or library. Study
and discuss them, including how to use the tax
tables. Note that tax rates increase with income
levels. Then note the kinds of deductions and
exemptions that taxpayers may take. Fill out a
return for a hypothetical family, using standard
deductions and itemized deductions.
Leonard Sanders
In March 1997 Paula Moore won $42 million in the
Massachusetts lottery. Like Leonard Sanders, she
believes in helping others. After aiding family and
friends, Moore donated $100,000 to her late
mother’s church. She also set up a college
scholarship earmarked for women like herself who
return to school late in life. The hospital that Moore
credits with saving her granddaughter’s life and the
Visiting Nurse Association also benefited from her
generosity.
Activity: Write a paragraph or two explaining what
you would do (and why) with the money if you won
the lottery.
Alan Greenspan
Alan Greenspan, chairman of the Federal Reserve,
was nominated by President Ronald Reagan and
took office in 1987. A moderate Republican,
Greenspan supports deregulation and believes that
the best way to check inflation is by limiting the
money supply. Because his remarks are subject to
intense scrutiny (and possible misinterpretation) by
the financial world, he is guarded in his
pronouncements. He says he “learned to mumble
with great incoherence” early on. “If I seem unduly
clear to you,” he has told visitors, “you must have
misunderstood what I said.”
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