Principles of Macroeconomics 1st

Edition Mateer Test Bank

Visit to download the full and correct content document: https://testbankdeal.com/dow
nload/principles-of-macroeconomics-1st-edition-mateer-test-bank/
CHAPTER 15

Federal Budgets: The Tools of Fiscal

Policy

CONCEPT MAP
I. How Does the Government Spend?
A. Government Outlays
B. Social Security and Medicare
1. Social Security
2. Medicare
3. Demographics
4. Fixing Social Security and Medicare
C. Spending and Current Fiscal Issues
II. How Does the Government Tax?
A. Sources of Tax Revenue
B. Payroll Taxes
1. Social Insurance Taxes
2. Income Tax
a. Historical Income Tax Rates
C. Who Pays for Government?
III. What Are Budget Deficits, and How Bad Are They?
A. Deficits
B. Deficits versus Debt
1. European Debt
C. Foreign Ownership of U.S. Federal Debt
1. Does China Own the United States?

MULTIPLE-CHOICE QUESTIONS
1. A budget is:
a. a record of income and purchases from the previous year.
b. a plan for spending and earning money.
c. only necessary for individuals with low incomes.
d. only necessary for countries suffering from financial crises.

1
 e. required to be balanced by Congress.
ANS: BDIF: Medium TOP: I.
REF: How Does the Government Spend?
MSC: Remembering
2. Should average citizens be concerned with the government’s budget?
a. No, because the government’s spending and tax policies do not affect citizens.
b. No, because even if citizens do not like the budget, there is nothing they can do to
influence it.
c. No, because the government is not spending the average citizen’s money; therefore, the
average citizen has no incentive to monitor the government’s budget.
d. Yes, because an important part of civic duty is voting on the yearly budget.
e. Yes, because the government’s yearly budget decisions have immediate and future
implications for levels of taxation and the provision of public goods.
ANS: E DIF: Easy TOP: I.
REF: How Does the Government Spend?
MSC: Understanding
3. Today, total annual government outlays in the United States are:
a. over $3 trillion.
b. over $6 trillion.
c. over $16 trillion.
d. less than $1 trillion.
e. equal to total annual revenue.
ANS: A DIF: Easy TOP: I.A.
REF: Government Outlays
MSC: Remembering
4. Between 2000 and 2010, real government outlays in the United States grew:
a. by less than 50%.
b. by more than 50%.
c. by more than 75%.
d. by more than 100%.
e. by less than 30%.
ANS: BDIF: Easy TOP: I.A.
REF: Government Outlays
MSC: Remembering
5. The largest portion of the federal budget is dedicated to:
a. discretionary spending.
b. mandatory outlays.
c. interest payments.
d. tax collection.
e. defense spending.
ANS: BDIF: Easy TOP: I.A.

2
 REF: Government Outlays
MSC: Remembering
6. Which of the following is considered mandatory government spending?
a. funding for the Environmental Protection Agency
b. payments to active military personnel
c. infrastructure maintenance spending
d. international aid to poor countries
e. payments to Social Security recipients
ANS: E DIF: Medium TOP: I.A.
REF: Government Outlays
MSC: Remembering
7. Which federal budget category’s portion of total government outlays has decreased since
1960?
a. Social Security
b. Medicare
c. Medicaid
d. defense
e. food stamps
ANS: D DIF: Easy TOP: I.A.
REF: Government Outlays
MSC: Understanding
8. Transfer payments refer to funds that are transferred from one group in society to another
group:
a. so these payments have no impact on the government budget deficit.
b. so these payments have no impact on the government debt.
c. so these payments are unfair to those who lose money in the transfer.
d. and these payments represent a growing share of U.S. federal outlays.
e. and these payments remain approximately constant over time.
ANS: D DIF: Medium TOP: I.A.
REF: Government Outlays
MSC: Understanding
9. Mandatory outlays are different than discretionary outlays because:
a. mandatory outlays usually change during the budget process, whereas discretionary
outlays do not.
b. mandatory outlays have been decreasing as a percentage of the federal budget, whereas
discretionary outlays have been increasing as a percentage of the federal budget.
c. discretionary outlays can be changed during the annual budget process, whereas
mandatory outlays cannot.
d. discretionary outlays include entitlement programs (such as Social Security and Medicare),
whereas mandatory outlays include important government programs (such as defense).
e. discretionary outlays comprise the vast majority of the total budget, whereas mandatory
outlays make up only a minor fraction.

3
 ANS: CDIF: Medium TOP: I.A.
REF: Government Outlays
MSC: Understanding
10. Why are interest payments considered mandatory spending in the federal budget?
a. They are considered mandatory spending because such payments are fixed at the time of
borrowing and cannot be altered.
b. They are considered mandatory spending because the interest rates on federal debt are
extremely high, and failing to pay accumulated interest would dramatically increase the
total debt.
c. They are considered mandatory spending because not making such payments could
endanger the government’s credit rating, which could make it harder to borrow going
forward.
d. They are considered mandatory spending because interest payments constitute the largest
part of yearly government spending.
e. They are considered mandatory spending because most interest payments go to American
households and those citizens depend on the interest payments for their livelihoods.
ANS: CDIF: Medium TOP: I.A.
REF: Government Outlays
MSC: Understanding
11. Mandatory outlays:
a. usually change during the budget process.
b. cannot be altered once they are made into law.
c. require changes in existing laws if those outlays are to be altered.
d. are a minor component of total outlays, and so are usually ignored.
e. are another name for discretionary outlays.
ANS: CDIF: Difficult TOP: I.A.
REF: Government Outlays
MSC: Understanding
12. Which of the following is considered discretionary government spending?
a. payments to Social Security recipients
b. payments to unemployment insurance recipients
c. payments to government employees
d. payments to food stamp recipients
e. payments to foreign bondholders
ANS: CDIF: Medium TOP: I.A.
REF: Government Outlays MSC: Applying
13. Assuming all of the following are in your personal monthly budget, your _____________
payment is considered a discretionary outlay.
a. mortgage (or rent, if you do not own a home)
b. car loan
c. student loan
d. electric bill

4
 e. boat loan
ANS: D DIF: Medium TOP: I.A.
REF: Government Outlays MSC: Applying
14. _____________ would be considered a mandatory outlay in your monthly budget.
a. A student loan payment
b. A donation to your alma mater
c. A grocery bill
d. Your electric bill
e. Gasoline money (for travel to and from work)
ANS: A DIF: Medium TOP: I.A.
REF: Government Outlays MSC: Applying
15. Discretionary government spending includes payments made for:
a. children’s health insurance program.
b. deposit insurance payments.
c. unemployment compensation.
d. the Department of Education.
e. pension payments for retired Coast Guard officers.
ANS: D DIF: Difficult TOP: I.A.
REF: Government Outlays MSC: Applying
16. Due to ____________, government outlays have risen quickly since 2000.
a. less tax revenue
b. an aging population
c. increased government borrowing
d. economic expansion
e. lower interest payments on current government debt
ANS: BDIF: Medium TOP: I.B.
REF: Social Security and Medicare
MSC: Understanding
17. ____________ a government-administered retirement program.
a. Medicare is
b. Medicaid is
c. Unemployment compensation is
d. Social Security is
e. Food stamps are
ANS: D DIF: Easy TOP: I.B.1.
REF: Social Security and Medicare
MSC: Remembering
18. When Social Security was first instituted by President Franklin Roosevelt in 1935, the payroll
tax rate on wages used to fund the program was:
a. 1%.

5
 b. 2%.
c. 3%.
d. 4%.
e. 5%.
ANS: BDIF: Medium TOP: I.B.1.
REF: Social Security and Medicare
MSC: Remembering
19. ____________ a mandated federal program that funds health care for retired persons.
a. Medicare is
b. Medicaid is
c. Unemployment compensation is
d. Social Security is
e. Food stamps are
ANS: A DIF: Easy TOP: I.B.2.
REF: Social Security and Medicare
MSC: Remembering
20. The funds used for payments to Medicare recipients come primarily from:
a. government borrowing.
b. donations from charitable organizations and citizens.
c. the employee’s portion of payroll taxes only.
d. the employer’s portion of payroll taxes only.
e. both the employer’s and employee’s portion of payroll taxes.
ANS: E DIF: Easy TOP: I.B.2.
REF: Social Security and Medicare
MSC: Understanding
21. The number of workers per Social Security beneficiary in 1960 was approximately:
a. 2.1.
b. 3.1.
c. 4.1.
d. 5.1.
e. 6.1.
ANS: D. DIF: Medium TOP: I.B.3.
REF: Social Security and Medicare
MSC: Remembering
22. Over the next 20 years, the number of workers per Social Security beneficiary is predicted to
be:
a. more than 5.
b. less than 5 but more than 3.
c. less than 3 but more than 2.
d. less than 2 but more than 1.
e. less than 1.

6
 ANS: C. DIF: Medium TOP: I.B.3.
REF: Social Security and Medicare
MSC: Remembering
23. Social Security and Medicare spending continue to grow and take up larger shares of the
federal budget because:
a. life expectancy is increasing, the number of people receiving benefits is increasing quickly,
and the growth in the number of people paying into the programs is decreasing.
b. life expectancy is decreasing, the number of people receiving benefits is increasing quickly,
and the growth in the number of people paying into the programs is decreasing.
c. life expectancy is increasing, the number of people receiving benefits is decreasing quickly,
and the growth in the number of people paying into the programs is decreasing.
d. life expectancy is increasing, the number of people receiving benefits is increasing quickly,
and the growth in the number of people paying into the programs is increasing.
e. life expectancy is decreasing, the number of people receiving benefits is decreasing quickly,
and the growth in the number of people paying into the programs is increasing.
ANS: A DIF: Difficult TOP: I.B.3.
REF: Social Security and Medicare
MSC: Remembering
24. Are demographics an important factor when planning the federal budget?
a. No, because government spending and taxation policies do not discriminate based on any
demographic factors.
b. No, because demographics do not change much from year to year.
c. No, because federal budgets do not change much from year to year.
d. Yes, because government benefits are allocated solely based on demographic factors.
e. Yes, because many government benefits are received by the fast-growing elderly
population, causing implications for future levels of taxation and government benefits for
everyone.
ANS: E. DIF: Easy TOP: I.B.3.
REF: Social Security and Medicare
MSC: Understanding
25. Why do Social Security and Medicare pose problems for the federal government budget?
a. The worker-to-retiree ratio is increasing.
b. Payroll taxes are capped and cannot be raised.
c. The number of retirees is decreasing.
d. The number of sick people is rising too quickly.
e. Life expectancy of retirees is increasing.
ANS: E DIF: Medium TOP: I.B.3.
REF: Social Security and Medicare
MSC: Applying
26. Why do Social Security and Medicare pose problems for the federal government budget?
a. The number of retirees is increasing.
b. The worker-to-retiree ratio is increasing.

7
 c. Life expectancy is decreasing.
d. The number of sick people is rising too quickly.
e. Social insurance taxes cannot legally be raised any further.
ANS: A DIF: Medium TOP: I.B.3.
REF: Social Security and Medicare
MSC: Applying
27. Why do Social Security and Medicare pose problems for the federal government budget?
a. The programs do not cover enough people.
b. The worker-to-retiree ratio is decreasing.
c. The number of retirees is decreasing.
d. The number of sick people is rising too quickly.
e. Social insurance taxes are capped and cannot be raised.
ANS: BDIF: Medium TOP: I.B.3.
REF: Social Security and Medicare
MSC: Applying
28. One proposed solution to the funding problems faced by Social Security and Medicare is to
implement means-testing, so that only those with limited retirement funds would qualify for
the government benefits. An unintended consequence of such a requirement may be:
a. an increase in private saving.
b. an increase in black market activity.
c. improved solvency for Social Security and Medicare.
d. fewer elderly people receiving benefits.
e. that some workers paying into the programs never receive any benefits from the programs.
ANS: B. DIF: Medium TOP: I.B.4.
REF: Social Security and Medicare
MSC: Understanding
29. One proposed solution to the funding problems faced by Social Security and Medicare is to
increase the retirement age from 67 to 70. Although this would mean billions of dollars in
savings for these federal programs, an unintended consequence may be:
a. a decrease in life expectancy.
b. an increase in the unemployment rate.
c. an increased number of elderly people in the workforce.
d. less incentive for people to work longer.
e. an increased incentive for people to work longer.
ANS: B. DIF: Difficult TOP: I.B.4.
REF: Social Security and Medicare
MSC: Understanding
30. Some proponents of entitlement-program reform suggest indexing Social Security benefits to
the consumer price index (CPI):
a. because beneficiary payments are not currently adjusted for cost of living increases.
b. rather than to the producer price index, because CPI historically grows at a faster rate,
which would mean benefit payments would grow at a faster rate.

8
 c. rather than to the producer price index, because CPI historically grows at a slower rate,
which would mean benefit payments would grow at a slower rate.
d. rather than to the average wage index, because CPI historically grows at a slower rate,
which would mean benefit payments would grow at a slower rate.
e. rather than to the average wage index, because CPI historically grows at a faster rate,
which would mean benefit payments would grow at a faster rate.
ANS: D. DIF: Difficult TOP: I.B.4.
REF: Social Security and Medicare
MSC: Understanding
31. Reforming entitlement programs is difficult because:
a. there is very little support for reform.
b. there are no good ideas for effective reform.
c. reforms require changes to existing law, which takes time.
d. all the reforms proposed are only short-term solutions.
e. the proposed reforms all require increases in existing tax rates, which are difficult to
achieve politically.
ANS: C. DIF: Difficult TOP: I.B.4.
REF: Social Security and Medicare
MSC: Understanding
32. Federal government spending has grown quickly since 2007 primarily because of:
a. expansionary fiscal policy in response to the Great Recession.
b. increased spending on bridge and road infrastructure.
c. increased foreign aid to disaster-stricken areas.
d. increased spending on the U.S. education system.
e. the bailout payments made to big banks.
ANS: A. DIF: Difficult TOP: I.C.
REF: Spending and Current Fiscal Issues
MSC: Remembering
33. Which of the following is not a revenue source for the U.S. federal government?
a. sales taxes
b. federal gasoline taxes
c. federal income taxes
d. payroll taxes
e. admission fees for national parks
ANS: A DIF: Medium TOP: II.
REF: How Does the Government Tax?
MSC: Understanding
34. In 2012, revenue from corporate income taxes totaled approximately:
a. 5% of total revenue.
b. 10% of total revenue.
c. 15% of total revenue.

9
 d. 20% of total revenue.
e. 25% of total revenue.
ANS: BDIF: Easy TOP: II.A.
REF: Sources of Tax Revenue
MSC: Remembering
35. Excise taxes are levied on:
a. property that is gifted to others.
b. imports.
c. individual income.
d. corporate income.
e. specific goods or commodities.
ANS: E DIF: Easy TOP: II.A.
REF: Sources of Tax Revenue
MSC: Remembering
36. Social Security and Medicare are funded by the collection of:
a. individual income taxes.
b. corporate income taxes.
c. payroll taxes.
d. excise taxes.
e. sales taxes.
ANS: CDIF: Easy TOP: II.A.
REF: Sources of Tax Revenue
MSC: Remembering
37. The largest source of tax revenue for the government is:
a. individual income taxes.
b. corporate income taxes.
c. social insurance taxes.
d. estate taxes.
e. excise taxes.
ANS: A DIF: Difficult TOP: II.A.
REF: Sources of Tax Revenue
MSC: Remembering
38. Which of the following is an example of something that contains an excise tax?
a. property
b. income
c. clothing made and sold in Oregon (where the sales tax rate is 0%)
d. clothing imported from China and sold in Oregon
e. tobacco products
ANS: E DIF: Medium TOP: II.A.
REF: Sources of Tax Revenue

10
 MSC: Applying
39. The government withdraws social insurance taxes from the paychecks of workers to:
a. discourage people from working.
b. pay the salaries of the members of Congress.
c. reduce the incidence of elderly poverty.
d. penalize wealthy workers.
e. collect money for international aid.
ANS: CDIF: Medium TOP: II.B.
REF: Payroll Taxes MSC: Understanding
40. The total current tax rate for Social Security and Medicare is:
a. 3.9%.
b. 6.2%.
c. 12.4%.
d. 15.3%.
e. 16.5%.
ANS: D DIF: Easy TOP: II.B.1.
REF: Payroll Taxes MSC: Remembering
41. The current tax rate for Social Security is:
a. 7.65% for the employee and 7.65% for the employer, if not self-employed.
b. 7.65%, if self-employed.
c. 6.2% for the employee and 6.2% for the employer, if not self-employed.
d. 1.45% for the employee and 1.45% for the employer, if not self-employed.
e. 12.4%, if self-employed.
ANS: A DIF: Medium TOP: II.B.1.
REF: Payroll Taxes MSC: Remembering
42 Some people argue that social insurance taxes should be increased to remedy the fiscal
problems faced by Social Security. What is a potential problem with this proposed solution?
a. This solution might only be a temporary fix, as it does not address the fundamental issue of
a growing elderly population and a shrinking working population.
b. It puts too much of the burden on the middle class and not enough on wealthy households.
c. It would eliminate the need for private savings, thus hurting banks.
d. This solution does not address the fact that the number of retirees is increasing.
e. Payroll taxes cannot be increased high enough to solve the problem.
ANS: A. DIF: Medium TOP: II.B.1.
REF: Payroll Taxes MSC: Understanding
43. Payroll taxes:
a. are not paid by individuals who are self-employed.
b. generate revenues earmarked for mandatory spending purposes.
c. generate revenues earmarked for discretionary spending purposes.
d. are based solely on income.
e. are not paid by people making over $110,100.

11
 ANS: BDIF: Medium TOP: II.B.1.
REF: Payroll Taxes MSC: Understanding
44. Some people argue that social insurance taxes should be increased to remedy the fiscal
problems faced by Social Security. What is a potential unintended consequence of this
proposed solution?
a. Federal tax revenues may increase.
b. The tax burden of the average worker may increase.
c. The disposable income of workers may decrease.
d. The elderly poverty rate may decrease.
e. The unemployment rate may increase.
ANS: E DIF: Difficult TOP: II.B.1.
REF: Payroll Taxes MSC: Understanding
45. Suppose you return to college and earn an MBA, after which you get an upper-management
position with Yum! Brands. If the tax rates are the same as in 2012 and your starting salary is
$125,000, how much will you owe in federal social insurance taxes?
a. more than $8,800
b. more than $8,400 but less than $8,800
c. more than $7,900 but less than $8,400
d. more than $7,300 but less than $7,900
e. less than $7,300
ANS: BDIF: Medium TOP: II.B.1.
REF: Payroll Taxes MSC: Applying
46. Suppose you return to college and earn an MBA, after which you get an upper-management
position with Yum! Brands. If your starting salary is $125,000, and the percentages are the
same as they were in 2012, how much will you owe in Social Security taxes?
a. more than $8,800
b. more than $8,400 but less than $8,800
c. more than $7,900 but less than $8,400
d. more than $7,300 but less than $7,900
e. less than $7,300
ANS: E DIF: Medium TOP: II.B.1.
REF: Payroll Taxes MSC: Applying
47. Suppose you land a job with Google right out of college. Your economics training is very
valuable to them, so you receive a starting annual salary of $65,000. What is the total amount
of social insurance taxes you will be responsible for after your first year of work?
a. $9,945.00
b. $4,030.00
c. $942.50
d. $9,750.00
e. $4,972.50
ANS: E DIF: Medium TOP: II.B.1.
REF: Payroll Taxes MSC: Applying

12
48. Suppose you use your entrepreneurial spirit and economics training to start your own
business. In your first year of work, you are able to earn $58,000 in gross income. What is the
total amount of social insurance taxes you owe the federal government?
a. $4,437.00
b. $7,192.00
c. $8,874.00
d. $3,596.00
e. $8,700.00
ANS: CDIF: Medium TOP: II.B.1.
REF: Payroll Taxes MSC: Applying
49. The United States has a:
a. progressive income tax system.
b. regressive income tax system.
c. marginal income tax system.
d. good income tax system.
e. bad income tax system.
ANS: A DIF: Easy TOP: II.B.2.
REF: Payroll Taxes MSC: Remembering
50. A progressive income tax system is one in which:
a. income tax rates decrease as earned income increases.
b. everyone pays the same tax rate, so that wealthier people pay a larger sum of taxes.
c. everyone pays the same tax rate, so that people with low incomes pay a smaller sum of
taxes.
d. income tax rates increase as earned income increases.
e. incomes taxes are based on occupation.
ANS: D DIF: Easy TOP: II.B.2.
REF: Payroll Taxes MSC: Remembering
51. A marginal tax rate is:
a. the tax rate paid on a worker’s next dollar of income.
b. equal to a worker’s income tax bracket.
c. the total tax paid divided by the amount of taxable income.
d. irrelevant for making decisions about earning extra income.
e. applied only to high earners under a progressive income tax system.
ANS: A DIF: Easy TOP: II.B.2.
REF: Payroll Taxes MSC: Remembering
52. If policymakers are concerned about the unequal distribution of income within society, then
they should prefer a:
a. regressive income tax system.
b. progressive income tax system.
c. consumption tax system.
d. proportional income tax system.

13
 e. per capita tax system.
ANS: BDIF: Easy TOP: II.B.2.
REF: Payroll Taxes MSC: Understanding
53. The most relevant tax rate for making decisions about earning additional income is the:
a. marginal tax rate.
b. income tax rate.
c. average tax rate.
d. sales tax rate.
e. property tax rate.
ANS: A DIF: Easy TOP: II.B.2.
REF: Payroll Taxes MSC: Understanding
54. Suppose you graduate with an accounting degree and then become a certified public
accountant. You work for a big firm, but are offered a chance to prepare tax documents for
your city government as an independent contractor. The city offers to pay you a consulting fee
of $10,000. When deciding whether to accept the additional work, the most important tax
factor in your decision is:
a. the gross amount of the payment.
b. your current tax bracket.
c. your new average tax rate.
d. which political party controls the city government.
e. your marginal tax rate.
ANS: E DIF: Difficult TOP: II.B.2.
REF: Payroll Taxes MSC: Understanding
55. Typically, the average tax rate for a person is ____________ their marginal tax rate, because
____________.
a. below; the marginal tax rate applies to all income
b. below; the marginal tax rate applies to the first dollars taxed, but not to all income
c. below; the marginal tax rate applies to the last dollars taxed, but not to all income
d. above; the marginal tax rate applies to the last dollars taxed, but not to all income
e. above; the marginal tax rate applies to the first dollars taxed, but not to all income
ANS: CDIF: Difficult TOP: II.B.2.
REF: Payroll Taxes MSC: Understanding
56. Suppose you are offered a $5,000 raise at work. Your current income tax rate is 25%. Your
marginal income tax rate is 28%. Your average tax rate is 20%. The additional income tax you
owe to the federal government (assuming you stay in the same rate bracket) if you accept the
job will be:
a. $1,250.
b. $1,400.
c. $1,000.
d. $250.
e. $150.
ANS: BDIF: Easy TOP: II.B.2.

14
 REF: Payroll Taxes MSC: Applying
57. Suppose you are offered a job with Amazon upon graduation. Your starting salary will be
$70,000, which will put you in the 25% federal income tax bracket. The total amount of
income taxes you pay is $13,530. Your average tax rate is approximately:
a. 25.0%.
b. 37.5%.
c. 31.3%.
d. 19.3%.
e. 12.5%.
ANS: D DIF: Easy TOP: II.B.2.
REF: Payroll Taxes MSC: Applying
58. According to the U.S. Federal Tax Rates chart from the textbook (Figure 15.6), a person earning
$100,000 in a given year is in the 28% tax bracket. How much will this individual owe in taxes
for that year?
a. $0
b. $28,000
c. more than $28,000
d. less than $28,000 but greater than $15,000
e. greater than $0 but less than $15,000
ANS: D DIF: Easy TOP: II.B.2.
REF: Payroll Taxes MSC: Applying

Refer to the following table to answer the next seven questions:

2012 Federal Income Tax Brackets

Taxable Income Tax Rate

$0–$8,700 10%
$8,701–$35,350 15%
$35,351–$85,650 25%

$85,651–$178,650 28%
$178,651–$388,350 33%

Over $388,350 35%

59. Using the table, what is the total federal income tax bill for someone who makes $67,000 per
year?
a. $16,750
b. $12,780
c. $11,169
d. $10,050
e. $6,700
ANS: BDIF: Easy TOP: II.B.2.

15
 REF: Payroll Taxes MSC: Applying
60. Using the table, what is the average tax rate for someone who makes $67,000 per year?
a. 10.0%
b. 14.2%
c. 16.7%
d. 25.0%
e. 19.1%
ANS: E DIF: Easy TOP: II.B.2.
REF: Payroll Taxes MSC: Applying
61. Using the table, what is the marginal income tax rate for someone who makes $67,000 per
year?
a. 10.0%
b. 14.2%
c. 16.7%
d. 25.0%
e. 19.1%
ANS: D DIF: Easy TOP: II.B.2.
REF: Payroll Taxes MSC: Applying
62. Using the table, what is the total payroll tax bill (assume zero state and local income taxes) for
someone who makes $67,000 per year?
a. $17,905.25
b. $23,030.75
c. $13,751.25
d. $16,933.75
e. $5,125.50
ANS: A DIF: Medium TOP: II.B.2.
REF: Payroll Taxes MSC: Applying
63. Using the table, what is the marginal income tax rate of a $5,000 raise for someone who
currently makes $67,000 per year?
a. 10%
b. 15%
c. 25%
d. 28%
e. 0%
ANS: CDIF: Easy TOP: II.B.2.
REF: Payroll Taxes MSC: Applying
64. Using the table, what is the marginal income tax rate of a $5,000 raise for someone who
currently makes $85,650 per year?
a. 10%
b. 15%
c. 25%

16
 d. 28%
e. 0%
ANS: D DIF: Easy TOP: II.B.2.
REF: Payroll Taxes MSC: Applying
65. Using the table, what is the new average tax rate for a person who currently makes $80,000
per year and receives a $10,000 raise?
a. 20.7%
b. 20.0%
c. 28.0%
d. 27.5%
e. 22.3%
ANS: A DIF: Difficult TOP: II.B.2.
REF: Payroll Taxes MSC: Applying
66. The U.S. federal income tax began in:
a. 1910.
b. 1911.
c. 1912.
d. 1913.
e. 1914.
ANS: D DIF: Easy TOP: II.B.2.a.
REF: Historical Income Tax Rates
MSC: Remembering
67. The highest marginal tax rate in 1913 was:
a. 2%.
b. 3%.
c. 4%.
d. 5%.
e. 6%.
ANS: E DIF: Easy TOP: II.B.2.a.
REF: Historical Income Tax Rates
MSC: Remembering
68. By 1918, the top marginal income tax rate in the United States rose to:
a. 77%.
b. 76%.
c. 75%.
d. 74%.
e. 73%.
ANS: A DIF: Easy TOP: II.B.2.a.
REF: Historical Income Tax Rates
MSC: Remembering

17
69. The highest marginal tax rate in U.S. history was:
a. 100%.
b. 98%.
c. 96%.
d. 94%.
e. 92%.
ANS: D DIF: Medium TOP: II.B.2.a.
REF: Historical Income Tax Rates
MSC: Remembering
70. The top 1% of households in the United States:
a. contribute no federal income tax revenues become of tax loopholes.
b. contribute nearly 40% of all federal income tax revenues.
c. contribute more than 50% but less than 75% of all federal income tax revenues.
d. contribute more than 75% but less than 90% of all federal income tax revenues.
e. contribute more than 90% of all federal income tax revenues.
ANS: BDIF: Medium TOP: II.C.
REF: Who Pays for Government?
MSC: Remembering
71. Why do wealthy citizens contribute much more tax revenues to the government than poor
citizens?
a. Wealthy citizens consume more government services, so they are taxed at a higher rate.
b. Wealthy citizens have a much lower average tax rate than poor citizens.
c. Wealthy citizens work more hours per week than poor citizens.
d. Wealthy citizens have much more taxable income than poor citizens.
e. Wealthy citizens do not contribute more tax revenues to the government than poor
citizens.
ANS: D DIF: Easy TOP: II.C.
REF: Who Pays for Government?
MSC: Understanding
72. The wealthiest 20% of households in the United States:
a. do not contribute their fair share of federal income taxes.
b. contribute the vast majority of all federal income taxes.
c. are forced to pay too much in federal income taxes.
d. pay zero federal income taxes because of tax loopholes.
e. contribute less than 50% of all federal income taxes because of tax loopholes.
ANS: BDIF: Easy TOP: II.C.
REF: Who Pays for Government?
MSC: Applying
73. The poorest 40% of households in the United States:
a. do not contribute their fair share of income taxes.
b. contribute the vast majority of all income taxes.

18
 c. are forced to pay too much income tax despite their low incomes.
d. pay negative income taxes because of tax credits and income assistance.
e. contribute an amount of income taxes proportionate to what they consume in government
services.
ANS: D DIF: Medium TOP: II.C.
REF: Who Pays for Government?
MSC: Applying
74. The middle 20% of households in the United States:
a. contribute more than 70% of all federal income tax revenues.
b. contribute less than 70% but more than 50% of all federal income tax revenues.
c. contribute less than 10% of all federal income tax revenues.
d. contribute no federal income tax revenues.
e. pay negative federal income taxes because of tax credits and income assistance.
ANS: CDIF: Medium TOP: II.C.
REF: Who Pays for Government?
MSC: Applying
75. A U.S. federal government budget deficit occurs when:
a. government revenue exceeds outlays.
b. government outlays exceed revenue.
c. government outlays equal revenue.
d. the United States borrows money from foreign countries.
e. the United States lends money to foreign countries.
ANS: BDIF: Easy TOP: III.A.
REF: Deficits MSC: Remembering
76. A U.S. federal government budget surplus occurs when:
a. government revenue exceeds outlays.
b. government outlays exceed revenue.
c. government outlays equal revenue.
d. the United States borrows money from foreign countries.
e. the United States lends money to foreign countries.
ANS: A DIF: Easy TOP: III.A.
REF: Deficits MSC: Remembering
77. The most recent federal budget surplus occurred:
a. never; the government has always run a budget deficit.
b. in 1959.
c. in 2012.
d. in 2006.
e. in 2001.
ANS: E DIF: Medium TOP: III.A.
REF: Deficits MSC: Remembering

19
78. During the Great Recession, government outlays were _________ and government revenues
were _________ their long-run averages over the period 1960–2012.
a. above; below
b. below; above
c. above; above
d. below; below
e. equal to; equal to
ANS: A DIF: Medium TOP: III.A.
REF: Deficits MSC: Remembering
79. What is the most appropriate way to compare budget deficits/surpluses across time?
a. using nominal dollar figures
b. using real dollar figures
c. calculating figures as a portion of gross domestic product (GDP)
d. using per capita dollar figures
e. Budget figures cannot be compared across time.
ANS: CDIF: Medium TOP: III.A.
REF: Deficits MSC: Remembering
80. If government revenues in 2011 were $2.2 trillion and government outlays were $3.8 trillion:
a. the federal debt was unaffected in that year.
b. the federal debt decreased $1.6 trillion.
c. the federal debt increased $1.6 trillion.
d. the federal budget surplus was $1.6 trillion.
e. the federal budget was balanced.
ANS: CDIF: Medium TOP: III.A.
REF: Deficits MSC: Understanding
81. Why did tax revenues fall so sharply after 2007?
a. Tax rates were drastically lowered.
b. A slowdown in economic activity increased unemployment.
c. Many people moved out of the country because of increased tax rates.
d. A large increase in the number of retirees led to a decrease in the amount of people paying
taxes.
e. Congress approved tax cuts in the prior year.
ANS: BDIF: Medium TOP: III.A.
REF: Deficits MSC: Understanding
82. Budget deficits tend to:
a. increase over time.
b. decrease over time.
c. increase during recessions.
d. increase during expansions.
e. grow as the economy grows and shrink as the economy shrinks.
ANS: CDIF: Medium TOP: III.A.

20
 REF: Deficits MSC: Understanding
83. The U.S. government could reduce its budget deficit by:
a. borrowing funds from abroad.
b. raising the eligible retirement age to receive Social Security benefits.
c. expanding the income assistance programs.
d. lowering income tax rates.
e. decreasing the level of means-testing for Medicare eligibility.
ANS: BDIF: Difficult TOP: III.A.
REF: Deficits MSC: Understanding
84. Why is a budget surplus not necessarily a good thing?
a. Saving money is not something a government should do.
b. It demonstrates a society that is too weak to stand up to the government.
c. It means the government thinks a recession is coming, so it is storing funds for the crisis.
d. The surplus money is divided among members of Congress, as a reward for managing the
economy well.
e. It means tax rates may be too high.
ANS: E DIF: Difficult TOP: III.A.
REF: Deficits MSC: Understanding
85. Why is a budget deficit not necessarily a bad thing?
a. Governments should always spend more than they collect in revenue to encourage
economic growth.
b. Saving money is not something a government should do.
c. As long as the government is paying for things it needs, it is appropriate to spend more
than is collected in tax revenue.
d. Deficits may allow for tax rate stability during recessions.
e. Because future generations will be better equipped to pay back any accumulated deficits.
ANS: D DIF: Difficult TOP: III.A.
REF: Deficits MSC: Understanding
86. Budget deficits tend to:
a. increase during expansions.
b. increase during wars.
c. decrease during recessions.
d. increase over time.
e. decrease over time.
ANS: BDIF: Difficult TOP: III.A.
REF: Deficits MSC: Understanding
87. Which of the following might be a good reason for running a budget deficit?
a. A budget deficit allows for consumption to be more evenly distributed over time, which
can be helpful during times of recession.
b. It puts the repayment burden on future taxpayers, who are better able to repay the
accumulated debt.

21
 c. It is better than increasing taxes, because budget deficits do not have to be repaid.
d. It allows for the expansion of entitlement programs to cover more people, thus reducing
their financial burdens.
e. There is never a good reason for running a budget deficit.
ANS: A DIF: Difficult TOP: III.A.
REF: Deficits MSC: Understanding
88. If government revenues in 2011 were $2.2 trillion and government outlays were $3.8 trillion:
a. the federal debt was unaffected.
b. the federal debt decreased $1.6 trillion.
c. the federal budget surplus was $1.6 trillion.
d. the federal budget deficit was $1.6 trillion.
e. the federal budget was balanced.
ANS: D DIF: Easy TOP: III.A.
REF: Deficits MSC: Applying
89. The federal budget deficit has grown so quickly in the past 5–10 years because of:
a. increased tax revenue.
b. increased spending on entitlement programs.
c. lower income tax rates on the top 1% of households.
d. economic expansion.
e. higher interest payments on current government debt.
ANS: BDIF: Easy TOP: III.A.
REF: Deficits MSC: Applying
90. If government revenues in 2000 were $2.0 trillion and government outlays were $1.8 trillion,
this means that:
a. the federal debt was unaffected in that year.
b. the federal debt increased $200 billion.
c. the federal budget deficit was $200 billion.
d. the federal budget surplus was $200 billion.
e. the federal budget was balanced.
ANS: D DIF: Medium TOP: III.A.
REF: Deficits MSC: Applying
91. The federal government started running a budget surplus in 1998. By 2002, the budget surplus
had turned into a budget deficit. Why do you think the budget deficit returned in 2002?
a. There were spending increases to reduce the impacts of the Great Recession.
b. Entitlement programs were expanded in 2002, causing outlays to exceed revenues.
c. There was increased military spending in response to the 9/11 terrorist attacks.
d. There were large decreases in tax rates, which reduced total tax revenues.
e. Politicians were spending the surplus too quickly on projects that would benefit their home
districts.
ANS: CDIF: Medium TOP: III.A.
REF: Deficits MSC: Applying

22
 92. According to the textbook, the country with the highest debt-to-GDP (gross domestic product)
ratio in the world, in terms of publicly held debt, is:
a. the United States.
b. Greece.
c. Italy.
d. France.
e. Japan.
ANS: E DIF: Easy TOP: III.B.
REF: Deficits versus Debt
MSC: Remembering
93. Should we be concerned about a growing federal debt?
a. No, because budget deficits are more important to worry about than the federal debt.
b. No, because federal debt, unlike private debt, does not have to be repaid.
c. Yes, because a large federal debt may slow the rate of economic growth in the future.
d. Yes, because if the debt grows too large, we will have to receive bailouts from other
countries, which means they will be able to control our policy and economy.
e. Yes, because it is likely that the government will confiscate the savings of individuals to pay
for the debt.
ANS: CDIF: Easy TOP: III.B.
REF: Deficits versus Debt
MSC: Understanding
94. Why does the federal debt tend to increase during periods of recession?
a. Economic activity decreases, which decreases revenues and increases outlays.
b. Economic activity decreases, which decreases revenues and decreases outlays.
c. Economic activity increases, which increases revenues and increases outlays.
d. Economic activity increases, which increases revenues and decreases outlays.
e. Economic activity increases, which decreases revenues and increases outlays.
ANS: A DIF: Medium TOP: III.B.
REF: Deficits versus Debt
MSC: Understanding

Use the following table to answer the next eight questions:

Public Debt over Time

2001 2011
Debt GDP Debt GDP

United $3.3 trillion $10.2 trillion $12.2 trillion $15.0 trillion

States

France $0.9 trillion $1.5 trillion $1.8 trillion $2.0 trillion

Italy $1.5 trillion $1.2 trillion $1.7 trillion $1.6 trillion
Belgium $0.3 trillion $0.3 trillion $0.3 trillion $0.4 trillion
Australia $0.2 trillion $0.7 trillion $0.4 trillion $1.4 trillion

23
95. According to the table, the country with the highest average yearly budget deficit over the
time period is:
a. the United States.
b. France.
c. Italy.
d. Belgium.
e. Australia.
ANS: A DIF: Easy TOP: III.B.
REF: Deficits versus Debt MSC: Applying
96. According to the table, the country with the lowest average yearly budget deficit over the time
period is:
a. the United States.
b. France.
c. Italy.
d. Belgium.
e. Australia.
ANS: D DIF: Easy TOP: III.B.
REF: Deficits versus Debt MSC: Applying
97. According to the table, the country with the highest average yearly budget deficit over the
time period as a percentage of the yearly increase in GDP is:
a. the United States.
b. France.
c. Italy.
d. Belgium.
e. Australia.
ANS: A DIF: Difficult TOP: III.B.
REF: Deficits versus Debt MSC: Applying
98. According to the table, the country with the lowest average yearly budget deficit over the time
period as a percentage of the yearly increase in GDP is:
a. the United States.
b. France.
c. Italy.
d. Belgium.
e. Australia.
ANS: D DIF: Difficult TOP: III.B.
REF: Deficits versus Debt MSC: Applying
99. According to the table, the country with the largest increase in the debt-to-GDP ratio over the
time period is:
a. the United States.
b. France.
c. Italy.

24
 d. Belgium.
e. Australia.
ANS: A DIF: Medium TOP: III.B.
REF: Deficits versus Debt MSC: Applying
100. According to the table, the country with the largest decrease in the debt-to-GDP ratio over the
time period is:
a. the United States.
b. France.
c. Italy.
d. Belgium.
e. Australia.
ANS: D DIF: Medium TOP: III.B.
REF: Deficits versus Debt MSC: Applying
101. According to the table, which country appeared to be in the worst fiscal shape in 2012?
a. United States
b. France
c. Italy
d. Belgium
e. Australia
ANS: CDIF: Medium TOP: III.B.
REF: Deficits versus Debt MSC: Applying
102. According to the table, which country appeared to be in the best fiscal shape in 2012?
a. United States
b. France
c. Italy
d. Belgium
e. Australia
ANS: E DIF: Medium TOP: III.B.
REF: Deficits versus Debt MSC: Applying
103. Which country faces the most severe fiscal challenges—in terms of debt-to-GDP
ratio—according to the accompanying table?

Public Debt across the World

Total Public Debt GDP

United States $15.2 trillion $15.6 trillion

Italy $ 2.9 trillion $ 2.2 trillion
France $ 2.3 trillion $ 2.7 trillion
Jamaica $ 0.3 trillion $ 0.2 trillion
Cyprus $ 0.2 trillion $ 0.2 trillion

a. United States

25
 b. Italy
c. France
d. Jamaica
e. Cyprus
ANS: D DIF: Medium TOP: III.B.
REF: Deficits versus Debt MSC: Applying
104. The austerity measures imposed on Greece in 2011:
a. were received well by Greek citizens, who were very concerned about their growing
national debt.
b. were forced onto Greece by the United States.
c. were a by-product of Greece’s default on the debt it owed to other European
governments.
d. required reforms to Greece’s large public sector in an attempt to decrease its debt and
help the country avoid default.
e. contained a list of recommendations from other European countries with the hopes that
Greece would voluntarily enact these reforms.
ANS: D DIF: Difficult TOP: III.B.1.
REF: Deficits versus Debt
MSC: Remembering
105. What would happen if a country defaulted on its sovereign debt?
a. It could lead to a deep recession—the effects of which might spill over into other countries.
b. It is impossible for a country to default on its debt.
c. Nothing, because other countries would step in to rescue the country.
d. The country and all its property would be sold in the international marketplace to the
highest bidder in an effort to repay creditors.
e. All the assets of the country’s citizens would be confiscated and sold to repay creditors.
ANS: A DIF: Medium TOP: III.B.1.
REF: Deficits versus Debt
MSC: Understanding
106. Why was the world so concerned about Greece defaulting on its debt?
a. People were afraid Greece would be sold to another country to pay its debts.
b. The U.S. government held a large quantity of Greek debt, so there was a concern that a
Greek default would cause a U.S. default.
c. Countries in the European Union held a large quantity of Greek debt, so there was a
concern that a Greek default would cause other European countries to default.
d. There were concerns that Greece would devalue its currency, leading to a severe recession.
e. Greece is one of the largest consumers in the world, so there were fears that a Greek
default would lead to a collapse in world demand.
ANS: CDIF: Difficult TOP: III.B.1.
REF: Deficits versus Debt
MSC: Understanding

26
107. Why is foreign government ownership of U.S. debt not currently a huge concern among many
economists?
a. It could lead to eventual foreign control of our economy and policies, which would
encourage economic growth in the future.
b. The United States has a proven track record of negotiating debt-forgiveness deals, so it is
unlikely that the debt will have to be paid back.
c. Foreign ownership of U.S. debt drives interest rates up, which is good for savers in the
United States.
d. The amount of debt held by foreigners is substantially less than the money the United
States owes itself.
e. Foreign countries would bail out the United States if its debt ever became too large to
manage.
ANS: D DIF: Easy TOP: III.C.
REF: Foreign Ownership of U.S. Federal Debt MSC: Understanding
108. In recent years, the growth in foreign-owned debt has:
a. substantially weakened the U.S. economy.
b. helped the U.S. economy by keeping the supply of loanable funds higher than it would be
otherwise.
c. harmed the U.S. economy by driving up the cost of borrowing.
d. harmed the U.S. economy by sending jobs overseas.
e. not affected the U.S. economy.
ANS: BDIF: Easy TOP: III.C.
REF: Foreign Ownership of U.S. Federal Debt MSC: Understanding
109. Which country holds the most U.S. debt?
a. China
b. United Kingdom
c. Japan
d. Germany
e. United States
ANS: E DIF: Easy TOP: III.C.1.
REF: Foreign Ownership of U.S. Federal Debt MSC: Remembering

SHORT-ANSWER QUESTIONS
1. Why has “entitlement reform” become such a major national issue?
ANS:
Entitlement programs, such as Social Security and Medicare, are mandatory spending
programs. Together, these two programs account for the largest share of the yearly
government budget; all entitlement programs combined account for more than half of the
budget. With a growing elderly population, the share of government spending allocated to
entitlement programs is predicted to grow quickly. As such, many experts have begun
discussing ways to reform the programs to reduce their costs.
DIF: Easy TOP: I. REF: Government Outlays MSC: Applying

27
2. The number of workers per retiree is a common feature in discussions of how to improve the
sustainability of the Social Security program. What was the approximate number of workers per
retiree when Social Security was first instituted? What is that number today? Discuss the
challenges this poses for the federal government budget.
ANS:
The number of workers per retiree was greater than 40 to 1 when Social Security was first
instituted. Now, the number of workers per retiree is approximately 2.9 to 1. That number is
predicted to decline further, to 2.1 to 1, over the next 40 years. This is problematic for the
federal government budget because as the number of retirees grows and the generosity of
the benefits in the program increases, there will be less tax revenue available per retiree. This
could eventually mean that the Social Security program will face insolvency. One way to
potentially slow this trend of the declining worker-to-retiree ratio is to increase the
retirement age, which would keep workers in the labor force for a longer period of time,
giving them more time to contribute to the program before they start receiving benefits.
DIF: Easy TOP: I.B. REF: Social Security and Medicare MSC: Understanding
3. One commonly proposed solution to the growing spending challenges faced by Social Security
and Medicare is to increase payroll taxes. What are some potential downfalls associated with
this solution? Explain.
ANS:
First, this policy could discourage firms from hiring workers, as it will increase employer costs.
This could lead to an increase in the unemployment rate. Second, such a policy is likely to be
a temporary solution, as it does not address the underlying problem of an increasing number
of retirees and a decreasing number of workers. Third, a payroll tax increase would be
especially hard on low-income earners, who are least able to absorb such losses in income.
DIF: Difficult TOP: I.B. REF: Social Security and Medicare MSC:
Understanding
4. Why is means-testing not likely to be a long-term solution for the rising costs associated with
Medicare and Social Security benefits? Fully explain your answer.
ANS:
Requiring means-testing would punish those who diligently save for retirement and reward
those who consume in the present with little regard for future consumption. This change may
prompt people to save less, which could exacerbate the existing cost problems faced by
Medicare and Social Security, as well as further add to the budget deficit.
DIF: Easy TOP: I.B.4. REF: Social Security and Medicare MSC: Understanding
5. What are the advantages and disadvantages of indexing Social Security benefits to the consumer
price index (CPI) rather than to the average wage index?
ANS:
One potential advantage is that, historically, the average wage index has risen faster than the
CPI. This means that indexing to the CPI may slow the growth in benefits, which would
improve the funding problem for the program. Recently, however, the CPI has increased
faster than the average wage index, so indexing to the CPI could add to short-term funding
problems. Another potential advantage is that CPI closely tracks the goods and services that
people purchase. Social Security is meant to supplement retirement income so that retirees
can purchase goods and services. Indexing to CPI makes sense because it more accurately
captures changes in the cost of living. However, people receiving Social Security benefits tend
to purchase disproportionately more medical care than does the average consumer (on

28
 whom the CPI is based). This implies that the CPI may understate the true changes in the cost
of living for the average retiree.
DIF: Medium TOP: I.B.4. REF: Social Security and Medicare MSC:
Understanding
6. Why are marginal tax rates the most relevant to consider when making financial decisions?
ANS:
The marginal tax rate is the tax rate paid on an individual’s next dollar of income. When a
person is deciding which job(s) to take, an important consideration is how much of the
income the person will get to keep after taxes. Knowing the marginal tax rate allows a person
to calculate that amount and make an informed decision.
DIF: Easy TOP: II.B.2. REF: Payroll Taxes MSC: Understanding
7. Suppose you are hired by the Federal Reserve Bank of Chicago as a financial analyst and your
starting salary is $75,000. Use the following table to calculate your total income tax burden.
Show your work.

2012 Federal Income Tax Brackets

Taxable Income Tax Rate

$0–8,700 10%

$8,701–$35,350 15%

$35,351–$85,650 25%

$85,651–$178,650 28%

$178,651–$388,350 33%

Over $388,350 35%

ANS:
($8,700 * 0.10) + [($35,350 - $8,701) * 0.15] + [($75,000 - $35,351) * 0.25] = $870 + $3,997.35
+ $9,912.25 = $14,779.60
DIF: Easy TOP: II.B.2. REF: Payroll Taxes MSC: Applying
8. Prior to the 1980s, the top marginal tax rates in the United States were very high (i.e., greater
than 70% during the Great Depression and afterward). Why is it unlikely that tax rates will ever
reach that level again?
ANS:
Various reasons make it unlikely that tax rates will soar to the same heights seen after the
Great Depression. First, raising tax rates to that level may be difficult to achieve politically, as
wealthy taxpayers have the means to form powerful political lobbies. Second, high marginal
tax rates create an incentive problem. That is, high marginal tax rates discourage people from
working because each additional dollar earned is taxed at a high rate. Thus, the opportunity
cost of leisure falls, which makes leisure more desirable. Third, as the world becomes
increasingly globalized, workers are more mobile and other countries have increased their
competitiveness for talented workers. High marginal tax rates could prompt high-earning
workers to leave the country for more attractive alternatives.
DIF: Difficult TOP: II.B.2.a. REF: Historical Income Tax Rates MSC:
Understanding
9. How is it possible for some people to pay “negative” taxes?

29
 ANS:
Some taxpayers, due to various tax credits and income assistance programs, actually receive
more money from the government than they pay in taxes. This implicitly means they are
paying a negative tax rate. The bottom 40% of taxpayers (by income) paid negative taxes
since the early 2000s. Food stamps, unemployment insurance, Medicaid, etc., are all forms of
government assistance that reduce the overall statutory tax burden for a taxpayer. Figure
15.8 in the textbook illustrates this trend.
DIF: Easy TOP: II.C. REF: Who Pays for Government? MSC: Understanding
10. Why may a budget deficit be considered undesirable?
ANS:
A budget deficit means that a country is collecting less in tax revenues than it is spending,
which has several possible implications. If this happens continually, then it will lead to a rising
government debt. At some point, creditors may begin to question a country’s ability to repay
its debts, which could lead to higher interest rates and less borrowing power for the indebted
country. In turn, economic growth may slow down, creating unemployment and other
recessionary circumstances.
DIF: Medium TOP: III.A REF: Deficits
MSC: Understanding
11. Why is it important to distinguish between deficits and debt?
ANS:
Budget deficits refer to revenue shortfalls for a particular year’s budget. Debt is the
accumulation of all deficits (and surpluses). Having a budget deficit for one particular year, or
even several consecutive years, is not particularly concerning in certain circumstances. For
example, if the country is in a recession or war, deficits are a good way to smooth
consumption and tax rates over time, as well as a means to share the burden with future
generations. However, persistent government deficits lead to a growing national debt. A
growing debt can be problematic because it may be difficult for a nation to fulfill its
obligations and it can mean large burdens for future taxpayers, each of which may lead to
slower long-run economic growth.
DIF: Medium TOP: III.A. REF: Deficits
MSC: Understanding
12. Why may a budget surplus be considered undesirable?
ANS:
A budget surplus means that a country is collecting more in tax revenues than it is spending,
which has several possible implications. It may be the case that the government leaders
cannot come to an agreement on which projects to fund, even if there are projects worthy of
funding. It may also be the case that there are no worthwhile projects to be funded. In either
case, the result is that taxes are too high because the government is collecting more than it
can spend. If the government leaders cannot decide how to spend the surplus, then it would
be more efficient to return the excess money to the taxpayers and let them decide how best
to spend the money.
DIF: Difficult TOP: III.A. REF: Deficits
MSC: Understanding
13. Why do the reported federal debt figures typically omit intragovernmental debt (debt that is
owned by agencies of the government itself)?

30
 ANS:
Technically, this is just money that the government has lent itself, moving funds from one
government agency to another. This is an attractive accounting feature for governments
because it makes the federal debt look relatively smaller. This is politically popular and also
allows a country to maintain a higher credit rating than it might otherwise have. However,
increasing levels of intragovernmental debt could eventually lead to funding problems for the
programs from which the funds are reallocated.
DIF: Difficult TOP: III.B. REF: Deficits versus Debt MSC: Understanding
14. Why may foreign ownership of U.S. debt be good for the United States? Why may foreign
ownership of U.S. debt be bad for the United States?
ANS:
Foreign ownership of U.S. debt provides valuable loanable funds to the U.S. economy. This
helps keep interest rates low, investment high, and economic growth steady. Without loans
from foreign countries, the United States would have to spend less or tax more, each of
which could potentially harm the economy, especially during recessionary periods. Foreign
ownership of U.S. debt may be bad because the low interest rates prompt savers to turn to
riskier investments, which is particularly harmful for people in or nearing retirement, of which
the United States has a large number. This could potentially place a larger burden on the
government, as upward pressure is placed on entitlement spending, forcing the government
to borrow more, thus continuing the cycle.
DIF: Medium TOP: III. REF: Foreign Ownership of U.S. Federal Debt
MSC: Understanding
15. Discuss the following assertion: China owns the United States.
ANS:
A common misperception is that China owns the vast majority of U.S. debt. In fact, China
currently owns less than 10% of U.S. debt. Japan holds nearly the same amount of U.S. debt
as China. The largest holder of U.S. debt is the United States itself. The Social Security Trust
Fund, U.S. Treasury, and U.S. households combined account for nearly 40% of total U.S. debt.
DIF: Easy TOP: III.C.1. REF: Foreign Ownership of U.S. Federal Debt
MSC: Evaluating

31