The government taxes us for two main reasons. The first is to run the functions of the government and provide the services, such as national security, regulation, commerce, and more. The second reason to tax us is for income redistribution through welfare payments, unemployment compensation, and aid to lower income people in the country. These payments are called transfer payments.
The government not only collects payroll taxes, it also collects corporate, social security, unemployment and other types of taxes. These are deductions from our GDP, and as such, the amount of taxes and the percent of GDP taxed influences the amount of consumer spending, corporate investment, and other aspects of the economy. This can be expressed simply:
This is true theoretically, but with a few minor adjustments, it is also true in the real world. Everything we make, we sell. The income from those sales goes to someone in the United States as income. So taxing GDP is taxing our national income, and the more the government takes, the less there is for consumers and corporations to spend. I am sad to say, though, that “the only certain things in life are death and taxes,” so taxes are here to stay. The U.S. government budget for fiscal year 2020 is below. (The government’s fiscal year 2020 runs from October 1, 2019, to September 30, 2020.) The numbers are in billions; for example, the total revenue for 2019, listed as 3,463, is $3 trillion and $463 billion.
Table 16.1. U.S. Government Budget for Fiscal Year 2020
Source: Congressional Budget Office, March, 2020.
Since budget numbers are changing every year and inflation is affecting our incomes and the cost of goods and services to the government, we should look at historical data so that we can evaluate whether these numbers are above or below average. Revenues and Outlays as percentages of GDP are a good benchmark. We can see those numbers in the chart below.
Table 16.2. Revenues, Outlays, Deficits (or Surpluses) and Debt Held by the Public, as a Percentage of GDP
The government’s revenue as a percent of GDP (the first column in the chart above) can be considered as the average tax rate. This is because GDP is equal to Gross National Income (GNI). That is, for everything made in the United States (the GDP), the money goes to someone or some corporation in the United States. According to the table above, when the revenue of the U.S. Government as a percentage of GDP decreases (often through tax cuts) and the Outlays as a percentage of GDP do not decrease (that is, no spending cuts), you get big annual deficits.
In theory, the government budget is similar to your household budget. If you spend more than you earn, you have to borrow from your credit cards to make up the difference. If a government spends more than they take in through taxes, it must issue more Treasury Bonds to finance that deficit, and, by definition, the national debt increases.
The problem with increasing your credit card debt or a government increasing its national debt is that you each have to pay it back. You or the government must make paying down the debt a priority over spending on anything else, or your credit rating goes down. More debt decreases your ability to buy goods and services. There is a crucial difference, though; you cannot easily increase your income if you have higher debt and want to maintain your former level of spending. On the other hand, governments can raise taxes to maintain their level of spending.