The Design of the Tax System

1
Chapter 12

• The Design of the Tax System

2
Ch 12 Outline

• Government Expenditures Revenues
• Tax Efficiency
• Tax Equity

3
... nothing is certain but death and taxes.
(B. Franklin)
Taxes in 1789 5 income
100
80
60
40
20
0
1789
4
...nothing is certain but death and taxes.
(Benjamin Franklin)
100
Today taxes 35 of income!
80
60
40
20
0
1789
Today
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The Tax System

• Government needs revenue.

6
The Tax System

• Taxes should impose a small cost on society
• should be efficient and equitable.

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Financial Overview of U.S. Govt

• Where govt gets its income
• What does the government spend its income on?
• Who contributes the most to the U.S. Government
  in the form of taxes?
• What does the government spend most of its
  income on?

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U.S. Economy Two major sectors

• Private Sector
• Two-thirds of U.S.economic activity .
• Public Sector
• other third

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The Government Sector Federal, State and Local

• The Federal Government collects about two-thirds
  of the taxes in our economy. (Table 12-1)
• Individual Income Taxes
• Social Insurance Taxes
• Corporate Income Taxes
• Excise Taxes
• Other

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Receipts of the Federal Government
Personal Tax
Social Insurance
Tax
Corporate Tax
Excise Tax
Other
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Individual Income Taxes... 1 Revenue Source

• Tax Liability
• Marginal Tax Rate
• Higher-incomes pay larger of income in taxes.

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Federal Government Spending

• Transfer payments govt purchases
• Transfer Payments
• Transfer payments 1source of govt expenses

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Spending of the Federal Government

• Expense Category
• Social Security
• National Defense
• Income Security

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Spending of the Federal Government
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Conditions of Federal Budget

• Budget Deficit
• Expenses gt Revenues.
• Budget Surplus
• Revenues gt Expenses

Why was 1998-2001 Budget Remarkable?
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National Debt

• National Debt - Sum of all past budget deficits
  surpluses

BUDGET SURPLUS AWARD
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US Debt /GDP
GDP
80 60 40 20 0
Declining Lately
GDP
1950 1960 1970 1980 1990 2000
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State Local Governments

• Receipts
• Sales Taxes
• Property Taxes
• Individual Income Taxes

• Expenses
• Education
• Public Welfare
• Highways

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Quick Quiz!

• What are the two most important sources of tax
  revenue for the federal government?
• What are the two most important sources for state
  and local governments?

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Taxes and Efficiency

• System efficient if raises same revenue at
  smaller cost

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Costs of Taxes to Taxpayers

• Costs
• Tax payment itself
• Transfer from taxpayer to govt.
• Deadweight losses
• Administrative burdens

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Deadweight Loss of Taxation
Say what?

• Deadweight Loss
• Lost total surplus - Tax Revenue

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Per Unit Tax on Good
Supply
Pe
Demand Before tax
Qe
24
Per Unit Tax on Good
S
Consumer Surplus
Pe
Producer Surplus
D
Qe
25
Per Unit Tax on Good
Supply
Pe
Demand Before tax
Qe
26
Per Unit Tax on Buyer to Raise
Supply
Pb
Demand after tax
Pe
Ps
Demand Before tax
Qt
Qe
27
Per Unit Tax on Good
Supply
Tax Wedge
Pb
Pe
Ps
Demand
Qt
Qe
28
Per Unit Tax on Good
Supply
Tax Wedge
Pb
Tax Rev
Pe
Ps
Demand
Qt
Qe
29
Per Unit Tax on Good
Consumer Surplus
Supply
Tax Wedge
Pb
Tax Rev
Pe
Ps
Demand
Producer Surplus
Qt
Qe
30
Per Unit Tax on Buyer to Raise
Supply
Demand after tax
Pe
Pt
Demand Before tax
Qt
Qe
31
Per Unit Tax on Good
Consumer Surplus
Supply
Tax Wedge
Pb
Tax Rev
Deadweight Loss
Pe
Ps
Demand
Producer Surplus
Qt
Qe
32
Per Unit Tax on Buyer to Raise
Supply
Pb
Tax Rev
Demand after tax
Pe
Ps
Demand Before tax
Qt
Qe
33
Per Unit Tax on Buyer to Raise
Consumer Surplus
Supply
Pb
Tax Rev
Demand after tax
Pe
Ps
Demand Before tax
Qt
Qe
34
Per Unit Tax on Buyer to Raise
Consumer Surplus
Supply
Pb
Tax Rev
Demand after tax
Pe
Ps
Demand Before tax
Producer Surplus
Qt
Qe
35
Per Unit Tax on Buyer to Raise
Consumer Surplus
Supply
Pb
Deadweight Loss
Tax Rev
Demand after tax
Pe
Ps
Demand Before tax
Producer Surplus
Qt
Qe
36
Per Unit Tax on Buyer to Raise
S
Consumer Surplus
Pe
Producer Surplus
D
Qe
37
Efficient Tax System

• Efficient tax system imposes small deadweight
  losses and small administrative burdens.

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Alternative Tax Rates

• Average Tax Rate...
• Total Taxes / Total Income
• Marginal Tax Rate...
• D Taxes / D Income
• Lump-Sum Tax Rate...
• Same Tax regardless of income

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Calculating Income Tax

• Taxable Income Marginal Rate
• 0 - 40,000 15
• 40,000-90,000 30
• Example Taxable Income 70,000
• Tax Due .15(40,000).30(70,000 - 40,000)
  15,000
• Average Tax Rate (Tax/Taxable Income) x 100
  
• 
  (15,000/70,000) x 100 21.4
• Marginal Tax Rate 30

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Quick Quiz!

• What is meant by the efficiency of a tax system?
• What can make a tax system inefficient?

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Taxes and Equity

• Is tax system fair?
• Benefits Principle
• Ability-to-pay Principle

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Taxes and Equity Benefit Principle

• ...pay taxes based on benefits received.
• Example
• Gasoline Tax finances highways .
• People who drive the most pay the most

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Taxes and Equity Ability-to-pay Principle

• ... based on ability to shoulder tax burden.
• Two equity ideas
• Vertical Equity
• Horizontal Equity

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Vertical Equity

• High incomes people should pay more tax.
• Systems
• Proportional
• Regressive
• Progressive

So how do these differ?
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Three Types of Taxes

• Proportional Regressive Progressive
• Tax1,000 1,000 1,000
• Income 10,000 10,000 10,000
• Tax/Inc 10 10 10
• Tax 5,000 2,000 8,000
• Income50,000 50,000 50,000
• Tax/Inc 10 4 16

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Tax Costs Administrative Burdens

• Question What are these?
• Includes time filling out forms.
• Payment for tax experts.

BUT YOU STILL CAN!
Shoulda Majored in Accounting!!!
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Horizontal Equity

• Families equal in income of dependents
  should pay same taxes.

What a blah slide!
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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?

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Conclusion The tradeoff between equity and
efficiency

• Equity and efficiency conflict.
• Changes in tax laws tradeoff efficiency equity

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Flat Tax

• Flat Tax 0.20 (Income - 10,000)
• Income Tax Ave Tax Rate
• 10,000 0 0.0
• 40,000 6,000 15.0
• 70,000 12,000 17.1
• 100,000 18,000 18.0

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Taxes and Equity

• Hard balancing goals of efficiency equity.
• Tax Incidence Studies who bears burden of taxes

CH 12 DONE!