Principles of Microeconomics : Ch.12 Second Canadian Edition
Chapter 12
The Design of the Tax System
© 2002 by Nelson, a division of Thomson Canada Limited
Principles of Microeconomics : Ch.12 Second Canadian Edition
Overview
Financial Overview of the Canadian Government
Taxes and EfficiencyTaxes and EquityConclusion
Principles of Microeconomics : Ch.12 Second Canadian Edition
“In this world nothing is certain but death and taxes.” (Benjamin Franklin)
In 1961, taxes accounted for about 28 % of total income!
19610
20
40
60
80
100
1961
Percent of total income
Principles of Microeconomics : Ch.12 Second Canadian Edition
“In this world nothing is certain but death and taxes.” (Benjamin Franklin)
Today, taxes account for
about 40 % of total income!
1961
To
day0
20
40
60
80
100
1961
To
day
Percent of total income
Principles of Microeconomics : Ch.12 Second Canadian Edition
The Tax System
When the government addresses the problem of externalities, provides public goods, or regulates the use of common resources, it can raise economic well-being.
For the government to perform these and its many other functions, it needs to raise revenue.
Principles of Microeconomics : Ch.12 Second Canadian Edition
The Tax SystemMost people agree
that taxes should impose as small a cost on society as possible, i.e...
… the tax system should be
efficient and equitable.
Principles of Microeconomics : Ch.12 Second Canadian Edition
A Financial Overview of the Canadian Government
Where does the government get its income from?
What does the government spend its income on?
Principles of Microeconomics : Ch.12 Second Canadian Edition
The Canadian Federal StructureThere are three levels of government -
federal, provincial, local.The B.N.A. Act sets out the responsibilities
of the federal and provincial governments.The local governments derive authority
from the provincial governments.The Federal government has unlimited
taxing powers.
Principles of Microeconomics : Ch.12 Second Canadian Edition
The Federal Government: Revenue
The major sources of tax revenue of the federal government include:
– Personal Income Taxes
– Corporate Income Taxes
– Goods and Services Taxes
– Payroll Taxes
– Other
Principles of Microeconomics : Ch.12 Second Canadian Edition
The Federal Government: Revenue
Personal Tax
Corporate Tax
GST
Payroll Tax
Excise Tax
Other
Principles of Microeconomics : Ch.12 Second Canadian Edition
Personal Income Taxes... The largest source of government revenue
Tax Liability is how much tax an individual owes and is based upon total income.
Marginal Tax Rate is the tax rate applied to each additional dollar of income. Higher-income individuals pay a larger percentage of their income in taxes.
Principles of Microeconomics : Ch.12 Second Canadian Edition
Federal Government Spending
About 30% of total government spending is on servicing the public debt.
The remaining 70% of government spending is called “Program Spending.”
Principles of Microeconomics : Ch.12 Second Canadian Edition
Federal Government Spending
Debt Service
Elderly Benefits
CHST
Subsidies & Transfers
EI
Defense
Other
Principles of Microeconomics : Ch.12 Second Canadian Edition
Financial Conditions of the Federal Budget
Budget Deficit– Situation where the expenses of the
budget are greater than the revenues.
– Government finances the deficit by borrowing from the public.
Budget Surplus– Situation where the revenues are greater
than the expenses. Used to pay outstanding debts.
Principles of Microeconomics : Ch.12 Second Canadian Edition
The Provincial Government: Revenue
Personal Tax
Transfers
Sales Tax
Excise Tax
Corporate Tax
Payroll Tax
Health Levies
Other
Principles of Microeconomics : Ch.12 Second Canadian Edition
The Provincial Government: Spending
Health
Education
Social Services
Debt Services
Other
Principles of Microeconomics : Ch.12 Second Canadian Edition
Local Governments: Municipalities and School Boards
Spending– Education
– Protection of People and Property
– Other
Receipts– Property Taxes– Transfers– Other
Principles of Microeconomics : Ch.12 Second Canadian Edition
Quick Quiz!What are the two most
important sources of tax revenue for the federal government?
What are the three most important expenditures for provincial governments?
Principles of Microeconomics : Ch.12 Second Canadian Edition
Overview
Financial Overview of the Canadian Government
Taxes and EfficiencyTaxes and EquityConclusion
Principles of Microeconomics : Ch.12 Second Canadian Edition
Taxes and Efficiency
The aim of a tax system is to raise revenue for the government. Two objectives of designing a tax system:
Efficiency
EquityA tax system is more efficient if it can
raise the same amount of revenue at a smaller cost to the taxpayers.
Principles of Microeconomics : Ch.12 Second Canadian Edition
Related Costs of Taxes to Taxpayers
The costs of taxes to taxpayers:– The tax payment itself
Transfer of money from taxpayer to government.
– Deadweight losses
– Administrative burdensAgain, an efficient tax system is one
which minimizes these costs.
Principles of Microeconomics : Ch.12 Second Canadian Edition
Deadweight Loss of TaxationWhen a tax is levied on buyers, the
demand curve shifts downward by the size of the tax...
When a tax is levied on sellers, the supply curve shifts upward by that amount... The losses to buyers and sellers exceed the tax revenue, leading to a
Deadweight Loss.
Principles of Microeconomics : Ch.12 Second Canadian Edition
Administrative & Compliance CostsAdministrative Costs include:
– Collection and enforcement expenses.Compliance costs include:
– The time spent in early spring filling out forms.
– Payment for tax experts in assisting the taxpayer in filing tax returns.
The cost to the taxpayer is greater than the actual tax payment made.
Principles of Microeconomics : Ch.12 Second Canadian Edition
The Goal of an Efficient Tax SystemAn efficient tax system is one that
imposes small deadweight losses and small administrative and compliance burdens.
Suggested strategies to enhance efficiency include:– simplifying the tax system
– broader based taxes
Principles of Microeconomics : Ch.12 Second Canadian Edition
Alternative Tax RatesEfficiency and equity of income taxes
leads to three notions of tax rates:Average Tax Rate...
...is total taxes paid divided by total incomeMarginal Tax Rate...
...is the extra taxes paid on an additional dollar of income
Lump-Sum Tax Rate......everyone owes the same amount of tax
Principles of Microeconomics : Ch.12 Second Canadian Edition
Quick Quiz!
What is meant by the efficiency of a tax system?
What can make a tax system inefficient?
Principles of Microeconomics : Ch.12 Second Canadian Edition
Overview
Financial Overview of the Canadian Government
Taxes and EfficiencyTaxes and EquityConclusion
Principles of Microeconomics : Ch.12 Second Canadian Edition
Taxes and Equity
How should the burden of taxes be divided among the population?
How do we evaluate whether a tax system is fair?
Benefits Principle
Ability-to-pay Principle
Principles of Microeconomics : Ch.12 Second Canadian Edition
Taxes and Equity: Benefits Principle
“People should pay taxes based on the benefits they receive from government
services.”Example:
– Gasoline Tax: These tax revenues are used to finance our highway system.
– People who drive the most, use the road the most, also pay the most toward their upkeep.
Principles of Microeconomics : Ch.12 Second Canadian Edition
Taxes and Equity: Ability-to-pay Principle
“Taxes should be assigned based on an individual’s ability to shoulder the tax
burden.”Two notions of equity:
Vertical EquityHorizontal Equity
Principles of Microeconomics : Ch.12 Second Canadian Edition
Vertical Equity“Differently situated individuals should
be treated differently.”Example: People with higher incomes
should pay more than people with lower incomes. – Alternative Tax Systems:
ProportionalRegressiveProgressive
Principles of Microeconomics : Ch.12 Second Canadian Edition
Horizontal Equity
“Would require people of like incomes to pay the same amount of tax.”
Example: Two different families with the same number of dependents and the same income living in different parts of the country should pay the same federal taxes.
Principles of Microeconomics : Ch.12 Second Canadian Edition
Taxes and Equity
The difficult part of tax policy is to balance the sometimes conflicting nature of the efficiency and equity goals.
The study of who bears the burden of taxes is central to evaluating tax equity. This is called Tax Incidence.
Principles of Microeconomics : Ch.12 Second Canadian Edition
Quick Quiz!
Explain the benefits principle and the ability-to-pay principle.
What are vertical equity and horizontal equity?
Why is studying tax incidence important in determining equity in a tax system?
Principles of Microeconomics : Ch.12 Second Canadian Edition
Overview
Financial Overview of the Canadian Government
Taxes and EfficiencyTaxes and EquityConclusion
Principles of Microeconomics : Ch.12 Second Canadian Edition
Conclusion: The tradeoff between equity and efficiency
Equity and efficiency are the two most important goals of the tax system. But often these goals conflict.
Many proposed changes in the tax laws increase efficiency while reducing equity, or increase equity while reducing efficiency.
Principles of Microeconomics : Ch.12 Second Canadian Edition
Overview
Financial Overview of the Canadian Government
Taxes and EfficiencyTaxes and EquityConclusion