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Government Revenue
Govt. provides goods generally not provided by the market ex – street lighting, highways, law enforcement, court
systemTax – Revenue – Nontax sources –
rights of govt. to tax are set down in the US Constitution and in state Constitutions
CERTAIN PRINCIPLES AND CRITERIA TO EVALUATE WHETHER OR NOT TAXES SHOULD BE PAID AND WHO SHOULD PAY THEM
MOST OFTEN BASED ON THE BENEFITS TAXPAYERS RECEIVE FROM TAXES AND THEIR ABILITY TO PAY
Principles of Taxation
-BENEFITS-RECEIVED PRINCIPLE-
Holds that ex – financing road construction & maintenance with
gas taxDifficult to assess how much different
taxpayers benefit from national defense, national parks, local police & fire protection, public education
-ABILITY-TO-PAY PRINCIPLE-
Holds that people with higher income will pay more than people
with lower incomes level of benefits received not a consideration income alone not completely determine ability to pay
taxesShould everyone pay the same % of income,
should those with higher incomes pay a higher % of their income in taxes
TAX SYSTEMS ATTEMPT TO MEET 3 CRITERIA:
THE CRITERIA ARE SOMETIMES IN CONFLICT AND A GIVEN TAX MAY NOT MEET ALL OF THE CRITERIA EQUALLY WELL
Criteria for Taxation
•-fairness of a tax is established by how uniformly the tax is applied
•-equity requires that people in similar situations pay a similar amount of taxes
•-some believe it requires that people with higher incomes pay more than people with lower incomes
EQUITY•-is determined
by how easy it is for the taxpayer to understand and how easy it is for the govt. to collect
•-should be no confusion about the time the tax is due and the amount to be paid•-sales tax
meets the criterion of simplicity
•-a set % of the price of a taxed item is collected every time that item is purchased
SIMPLICITY
•-can be judged by how well the tax achieves the goal of raising revenue for the govt. with the least cost in terms of administration
•-from taxpayer view – can be judged by the amount of effort and expense it takes to pay the tax•-individual
income tax – best meets the criterion of efficiency
EFFICIENCY
INDIVIDUAL INCOME TAX
SALES TAX
-is a tax based on an individual’s income from all sources: wages, interest, dividends, tips
-all taxes ultimately come from income – but using that as a tax base means amount of tax is directly linked to person’s earnings
-for most – income comes from wages or tips & could come from investments and savings in form of interest & dividends
-corporate income tax – is a tax based on a corporation’s profits
-is a tax based on the value of designated goods or services at the time of sale
-generally imposed on a wide range of goods and services
-is usually a % of the price of the good or service & is included in final price customer pays
-seller then passes the tax revenue on to govt.
Tax Bases
Tax Bases-PROPERTY TAX-
Is a tax based on the value of an individual’s or business’s assets, generally real estate
Home & business owners pay based on value of buildings and land on which buildings stand
Growing and shrinking tax base – wealth that is available to be taxed personal income rises
– If fewer homes or
businesses in a locality or value declines – tax base shrinks – less wealth for govt. to tax
Proportional tax
Progressive tax
•
Regressive tax
•takes a larger % of income from people with low incomes than from people with high incomes
-PROPORTIONAL TAX- -PROGRESSIVE TAX-
Sometimes called a flat tax – ex- all taxpayers might have a flat
15% tax on their income no matter how much income is
ex – earn $20,000 – pay $3,000 in taxes
ex – earn $50,000 – pay $7,500 in taxes
Some states & local govt. have proportional taxes in individual income Michigan – flat income tax rate of
3.9% Massachusetts – flat income tax
rate of 5.3%
Tax in which the tax rate increases as a person’s income increases high income person pays more in
amount of taxes but also pays a higher % of income in taxes
see figure 14.1 – progressive tax is most closely linked to the ability to pay principle
in US – federal income tax is a progressive tax – tax rate increases as income increases
may states have progressive income taxes: Cal., Kansas, NY, South Carolina
-REGRESSIVE TAX-
The % of income paid in taxes decreases as income increases some taxes are regressive b/c they
are applied to sales not income ex – a sales tax is applied equally to
all items subject to the tax, the tax as a % of income is regressive
this is b/c low income earners tend to spend a higher proportion of income than do high income earners
EX – state charges 5% sales tax Jones- earn $20,000, spend
$15,000 on taxable goods, pay $750 in sales taxes, (5% of 15,000) or 3.75% of income
Smith – earn $50,000, spend $25,000 on taxable goods, pay$1,250 in sales tax (5% of $25,000) or 2.5% of income
Property taxes on homes also considered regressive low income usually spend
higher % of their income on housing than high income
therefore – property taxes take a higher % of their income
poorer communities often charge a higher tax rate b/c property has a lower value then tax base is smaller
even non-home owners are subject to the regressive tax
Effect of Elasticity on Taxes
Govt. imposed a $1 tax on a product – demand elasticity influences the incidence of this tax if elastic demand – if inelastic demand –
Seller recognizes that quantity demanded will go down only slightly for goods and services that have elastic demand b/c hey are less price sensitive
TAXES HAVE IMPACT ON
GOVT. CHOOSES WHAT TO TAX BASED ON AMOUNT OF INCOME IT WANTS TO RAISE AND THE OTHER ECONOMIC EFFECTS IT WANTS TO ACHIEVE
Impact of Taxes on the Economy
Impact 1: Resource Allocation
Tax placed on a good or service will increase the costs of production and therefore shift the supply curve to the left if demand remains the same – price will go up will likely cause a shift is resources
If a supplier not able to pass increased costs to consumer in form of higher prices – may choose to shift production to another good that is more profitable ex – govt. imposed 10% tax on luxury yachts – producer not
able to raise prices enough to cover entire tax – no longer profitable – shift to small fishing boats or new business
Impact 2: Productivity and Growth
When taxes on interest & dividends are high, people tend to save less than when taxes on this source of income are low taxes have impact on
economists say high taxes reduce incentives to work
People may spend more time of things other than work if large % of income goes to taxes others suggest underground economy is result of high taxes
Underground economy – ex- Bob’s landscaping business – work weekends – charges
less than large firms – insists on being paid in cash – difficult for govt. to tax income
Impact 3: Economic Behavior
Tax incentive – providing tax credits or rebates – govt. may encourage
behavior it believes is good for the economy and society
ex- tax rebates for businesses opening new factories, offices & stores in economically depressed areas
ex – govt. give tax credits to consumers for recycling or using energy more efficiently
Positive tax credit with widest impact –
Impact 3: Economic Behavior
Sin taxes – gambling, alcohol, cigarettes
Taxes are generally levied on products or activities for which there is relatively inelastic demand – but – demand is relatively inelastic – the decline in
quantity demanded will not cause tax revenues to decrease dramatically
demand for sin-tax products becomes somewhat more elastic as tax increases get steeper
ex – in Washington – cigarette sales fell 19% year after imposed $.60 per pack tax – but revenue went up 40%
Individual Income Tax
Federal govt. takes in $2.5 trillion in revenue each year comes from many sources: individual income tax,
social insurance taxes, corporate income taxes, estate taxes, gift taxes, excise taxes, customs taxes
largest source – started using after
prior – excise taxes and customs duties main source social insurance taxes are workers and employers share the burden of these
taxes
Example: Paying Your Taxes
If taxpayers had to pay at end of year in one lump sum – would be difficult would be difficult for govt. getting revenue once a year drawing up a budget, developing a sound economic plan
for future impossibleTo make it easier – Withholding –
ex – Scott – works part-time during school, full-time during summer - $6 hr. b/c of withholdings – pays taxes as he earns income – govt. has steady stream of
revenue employer forwards withholdings to IRS
Example: Paying Your Taxes
IRS – federal income tax is a progressive tax based on the ability to
pay principle of taxation people with higher incomes not pay more in total taxes but also
a higher % of their income in taxesTaxable income –
under federal income tax laws – taxpayers can take certain exemption & deductions from total earned income to reduce amount of their taxable income
exemptions for each individual adult and child – larger family reduce more than smaller family
may take standard deductions or itemized deductions – interest paid on a home mortgage, state & local taxes, charitable contributions, certain portion of medical expenses
Tax return – Federal tax return shows –
state & local tax return show similar but less detailed information
if too much tax withheld – receive a refund for overpayment
if not enough withheld – then owe a payment to the IRS or state or local revenue dept.
Example: Indexing
The level of income that causes someone to pay a higher rate of taxis the dividing point between tax brackets the tax bracket is IDed by the tax rate for that income
span 2006 tax schedule – see p. 422 ex – Scot has taxable income of $7,000 – in 10% tax
bracket & pays 10% or $700 if earned $8,000 of taxable income – would be in 15%
tax bracket – would pay 10% on first $7,550 of earnings – then 15% on remaining $450
total would be $822.50 – or 10.3% of income
Example: Indexing
Indexing is ex- Scott’s income increases to $8,320 – 4% increase –
due to inflation w/o indexing - $770 of income is taxed at 15% and
pays $870.50 or 10.5% w/indexing – beginning level of 15% bracket is
adjusted by 4% to $7,852 so he still pays 10.3% of income in taxes
Indexing combats the
-FICA –
ALSO KNOWN AS SOCIAL INSURANCE – ENCOMPASSES SOCIAL SECURITY & MEDICARE
BOTH EMPLOYERS & EMPLOYEES MAKE CONTRIBUTION
FICA: Taxes to Ease Hardships
-SOCIAL SECURITY- -MEDICARE-
Is a began during the
Great Depression of the 1930s
employer & employee each pay 6.2 % of employee’s income up to an annual max
limit generally rises each year
Is a started in 1966 employers &
employees each pay 1.45% of employee income
no limit on amount of income subject to the tax for Medicare
-UNEMPLOYMENT TAXES-
Is a program provides benefits for a certain period of time to
employees who lose their jobs through no fault of their own
tax applies to first $7,000 earned by an employee and for most part is paid only by employers
-GOVT. ALSO USES CORPORATE INCOME, ESTATE,
GIFT, AND EXCISE TAXES AS WELL AS CUSTOMS DUTIES
AND USER FEES TO FINANCE OPERATIONS
Corporate Income and Other Taxes
Corporate Income Taxes
Corporate income tax is 3rd largest sources of revenue
1941-1968 – corporate income tax receipts have increased in total
dollars since mid-1900s, but have decreased relative to total federal income tax revenues and overall size of economy
Corporate Income Taxes
Only certain types of corporations are subject to corporate income tax
Corporations make up about 8% of all businesses that file tax returns Tax rate for most is 35% of
profits – most pay about 26% of profits in taxes
Corporations can deduct certain expenses from profits to reduce taxable income Deductions for investments in
buildings, equipment, and research & rules that benefit multinational corporations
Common criticism – profits are taxed at
corporate level and again at individual level
b/c shareholders pay taxes on income received in form of dividends or capital gains
Recent years –
• is a tax on property that is transferred to others on the death of the owner•most
estates not subject b/c govt. only taxes large estates
•2006 – estates larger than $2 million not subject
estate tax
•– is a tax on money or property given by one living person to another•-there
are exemptions – allow family members to give money to other family members tax-free
gift tax
•– is a tax on the production or sale of a specific product (ex – gas or telephone service)•-ex –
sin tax
•-govt. places excise tax on goods or services for which there is relatively inelastic demand in order to maintain a steady stream of revenue
excise tax
•– is a tax on goods imported into the US from another country•-basically
excise taxes on imports also called tariffs
customs duty
•– is money charged for the use of a good or service•-as based
on benefits received principle of taxation
•-ex – govt. charges entrance, parking and camping fees for national parks•-people
enjoying the park pay for the benefits
user fee
Economic Pacesetter: Maya MacGuineas: Reforming the Tax System
Says current system is complicated, inefficient, unfair, & doesn’t raise funds to fund all programs new system should be
based on simplicity, efficiency, equity & responsible budgeting
says income tax should be simplified by ending most tax deduction and exemptions
Would make the system more equitable – taxpayers in higher marginal tax bracket gain greatest benefit believes corporate tax
should be phased out supports environmental
taxes, different approach to how estate tax is levied
restructuring of nation’s entitlement programs
Most revolutionary idea is about FICA taxes – should be replaced with progressive consumption tax would be tied to spending
rather than income – rates rising as spending levels rise
ex – spending between $0 - $20,000 – no tax
spending between $20,000 - $50,000 – taxed at 10%
spending between $50,000 - $175,000 – taxed at 15% then so on
would be simpler & fairer & provides tremendous incentives to save
Federal Expenditures
Programs & services federal govt. funds with revenues are divided into to categories:
Mandatory spending – spending that is required by current law ex –
Discretionary spending – ex- funding for highway construction or maintenance
of national parks govt. has required funding and cover everything else
with what is left over
Type 1: Mandatory Spending
Makes up well over half of all federal spending
Entitlements – Social Security & Medicare –
many not “means tested” – anyone who meets the eligibility requirements receives the benefits regardless of income level
for other programs – income level is part of the requirements
-SOCIAL SECURITY-
Takes largest amount of federal spendingProvides benefits to older retired workers,
disabled workers with limited incomes & survivors of workers who have died is financed through payroll tax
Workers must have worked a certain period of time before they are eligible to receive full benefits with older population and more retired people – costs
have increased
To help – govt. has raised the age of full retirement – the point at which a worker is eligible to receive max benefits retirement benefits are not means tested if retiree has additional income – benefits may be
subject to withholdings ex – 2006 – if earn more –
-MEDICARE- -MEDICAID-
Induced in 1966 as additional old-age benefit under Social Security
Originally – provided hospital insurance for those over 65(funded by payroll taxes) & optional medical coverage for items such as doctor bills(funded by premiums paid by those choosing the coverage & general tax revenues) b/c of increasing # of retirees & health
care costs – costs have risen dramatically
Starting 2006 – means testing added for all but lowest
income group of senior citizens some coverage added for prescription
drugs
Is a joint federal-state medical insurance program for low-income people federal govt.
funds about 63% & states pay about 37%
recently – states tighten eligibility requirement to control costs
-OTHER MANDATORY SPENDING PROGRAMS
Variety of other mandatory spending programs that define eligibility requirements then funded based on an estimate of how many people must meet those requirement Food Stamp program provides funds for 26 million low-income people
to purchase foodVeterans’ benefits include health care coverage, disability
payments for service-related illness or injury also eligible for education assistance govt. spends about $50 billion on veterans’ benefits payments for federal portion of unemployment insurance part of this
Federal govt. pays its workers some retirement benefits Federal employees hired after 1983 eligible for some Social Security
retirement benefits
Type 2: Discretionary Spending
More than 1/3 of federal revenue is devoted to discretionary spending
Several categories: interstate highway system & transportation programs
(Amtrak) natural resources and the environment – education – science, space, technology, and other research
programs justice administration, including enforcement
agencies (FBI & federal court system)
Type 2: Discretionary Spending
Largest category – national defense – takes up 50% of total discretionary budget includes large amount of nation’s military spending –
Not all of this is discretionary spending some - homeland security (border protection and
enforcement of immigration laws) falls into mandatory expenditure
certain military spending falls outside the basic federal budget – wars in Iraq & Afghan
The Federal Budget and Spending
Federal budget – Fiscal year –
federal budget is prepared for a fiscal year the fiscal year runs from Oct. 1 to Sept. 30
President’s budget is prepared by the Office of Management and Budget (OMB) and takes into account estimated tax receipts and requests by all federal departments and agencies
Congress Acts on the Budget
Congressional Budget Office helps House and Senate develop guidelines for different appropriations appropriations – members of Congress often make deals to gain votes
for appropriations they supportCongress votes of final budget and send to
pres. for approval if not approved by beginning of fiscal year –
Methods of Federal Spending
After approval – funds spent in several ways one way – direct spending – by which the govt. buys
goods and services that it needs to operate ex – military equipment & office supplies & salaries of
govt. employees second way – transfer payments – money distributed
to taxpayers who do not provide goods or services in return
Grant-in-aid –
-TRANSFER PAYMENTS- -GRANTS-IN-AID-
Generally part of mandatory spending ex – Social Security
retirement or disability benefits and health care benefits from Medicare or veterans’ programs
taxpayers do not provide specific goods or services in exchange for these govt. funds
Transfer payments between levels of govt. federal govt. makes
grants to states, local govt., and regions
grants designated for specific categories of activities
ex – highway construction, certain school services, Medicaid funding
-RESOURCE ALLOCATION-
Federal govt. makes choices concerning where to spend money and on what to spend it influences how resources are allocated ex – if money goes to urban transit – cannot go to fix
rural roads
-INCOME REDISTRIBUTION-
Govt. spending affects the incomes of families, individuals, & businesses transfer payments for health care, retirement, Food
Stamp benefits – how govt. awards work contracts can also influence
distribution of income ex –
-COMPETITION WITH THE PRIVATE SECTOR-
Govt. may produce goods or services that are also produced in the private sector ex – ex –
State Revenue
Comes from a variety of sources –
Also raise funds from state sales taxes & state income tax on individuals & corporations
Type 1: Sales and Excise Taxes
All states except Alaska, Delaware, New Hampshire, Montana, & Oregon levy a state sales tax rates range from 2.9% in Colo. To 7.25% in Cali. generally applied to most goods & services sold within the state many states exempt food and prescription drugs
Some states tax these goods and over-the-counter-drugs and other medical supplies at a lower rate charitable, religious, and educational organizations often exempt all states have excise taxes on cigarettes, alcohol, gas, & diesel fuel
Certain govt. organizations, volunteer fire-fighting companies, & farmers may be exempt from fuel taxes
Many states have special sales taxes that mostly affect tourists (car rentals, hotels & motel rates)
Type 2: Income Tax and Other Revenue Sources
Income tax accounts for most states levy on both individual & corporate
income Alaska, Florida, & Texas have no individual income tax
Nevada, South Dakota, Washington, Wyoming levy neither individual nor corporate income taxes most states have progressive tax rate on individual &
flat tax rate on corporate rate vary from 0.36% for lowest tax bracket in Iowa to
9.5% for highest tax bracket in Vermont
Average state corporate tax rate is 6.8% low of 1% for lowest bracket in Alaska & Arkansas to Pennsylvania’s
flat rate of 9.99% many state govt. structure corporate tax rates to attract businesses govt. use tax cuts & incentives for businesses to promote economic
developmentStates receive benefits from these tax practices in
increased economic activity revenue from other sources estate taxes and user fees – same as federal govt. levy property taxes
Charge fees related to business operations – registration fees for certain types of businesses and license fees for doctors, dentists, lawyer and accountants