Download Taxes and Taxation

Taxes and Taxation
Why are there taxes?
•Main reason: to
raise revenue for
the government
What are some other reasons for taxation?
• To encourage some kinds of economic
activity (e.g., home ownership -- see the
mortgage interest deduction)
• To discourage consumption of some
items (alcohol, tobacco)
• To reprice items in the economy. When
the government pays farmers a subsidy
for a crop, for instance, the government
is using taxpayers’ money to price items
differently than would be the case in a
free market economy.
• To redistribute income and/or wealth
If taxes are a necessary evil, what principles
should guide the design of a good tax system?
Adam Smith and his four principles of taxation
• 1. Equity (i.e., fairness)
• 2. Certainty or predictability
• 3. Convenience (for the
contributor to pay the tax)
• 4. Efficiency
Equity
• Equity in taxation concerns fairness, the
idea that the tax system should be fair
• Something to consider: Do taxes impose
the same burdens on those in different
economic circumstances?
• Who should pay taxes?
• Two different, competing criteria.
1. The ability-to-pay principle. People
with higher incomes should pay more tax.
2. The benefits-received principle. Those
who benefit from a particular government
program should pay for it.
Deadweight loss of taxation (caused
by an inefficient tax)
• “A deadweight loss occurs when
the cost to consumers and
producers from a tax – due to lost
productivity or sales – is larger
than the size of the tax revenue it
generates.” (Econ Alive, p. 235)
• A deadweight loss usually means
that someone is worse off (in terms
of cost) while no one is better off
(in terms of benefit).
• In the diagram to the right, D and E
represent deadweight loss.
Different types of taxation
•Proportional taxes
•Progressive taxes
•Regressive taxes
Proportional (or flat) tax
• A proportional tax is a tax that takes the
same share of income at all income levels.
• If for example we had a proportional
income tax for individuals in the United
States right now, say 20%, Bill Gates and a
worker at a fast-food restaurant would pay
tax at the same rate.
• An advantage: Proportional taxes (aka flat
taxes) are simpler to figure out and
administer than other kinds of taxes
• A disadvantage: It doesn’t seem fair that a
billionaire and a poor person should pay tax
at the same rate.
• Look at the graph on the right: which line
(A, B, C or D) represents a proportional tax?
Progressive tax
• A progressive tax is a tax that
takes a larger share of income as
income increases.
• It is based on the ability-to-pay
principle.
• Supporters of progressive taxes
say that it is fairer.
• Opponents say that it really isn’t
fair. In fact, it penalizes those
who work hard to gain more
income.
Regressive tax
• A regressive tax is a tax that
takes a smaller share of income
as income increases.
• A proportional tax can also be
regressive if it takes a bigger bite
out of the incomes of poor
people than rich people.
• A sales tax is usually regressive.
A VAT (or value-added tax) is
often regressive also.
Different kinds of taxes
Income tax (personal and corporate)
• Personal income tax is a tax assessed on someone’s
annual income.
• It can be levied by federal, state and local
governments.
• At the federal level it is a progressive tax.
• Corporate income tax, on the other hand, is
applied to the profits of corporations. Like the
individual income tax, it is progressive at the
federal level.
• Critics of this tax on business allege that it is simply
passed on to consumers. It diminishes business
activity.
• Some critics claim that the corporate income tax in
the U.S. is too high compared to other countries
and should be reduced.
The inheritance (or estate) tax
• An inheritance or estate tax is a tax
that is levied on some or all of the
estate (property and possessions)
that a person leaves behind at
death. The heirs must pay the tax.
• These taxes are essentially the
same; the main difference is that
they are called estate taxes at the
federal level and estate or
inheritance taxes at the state level.
• Estate taxes are progressive; the
more you inherit, the higher the
rate of tax.
Luxury tax and Excise tax
• Luxury taxes are levied on the
sale of luxury items (yachts and
private jets, e.g.). They are
progressive taxes.
• Excise taxes are usually levied on
goods the government wants to
regulate (e.g., alcohol and
tobacco). These taxes are
sometimes called sin taxes. They
are generally regressive taxes.
Property tax
• Property taxes are commonly
levied on real estate (buildings,
land, etc.).
• Some states levy them on cars,
motorcycles and boats also.
• They are a major source of
funding for schools.
Sales tax
• A sales tax is paid for by the
customer when he or she
purchases various goods or
services.
• It is generally regressive.
• It is levied by states and
some cities.
User fees and tolls
• User fees and tolls are
charged for the use of
public facilities and
services.
• User fees are also
required for permits and
licenses.
Different parts of the federal budget
• The federal budget is composed
of two main parts: mandatory
spending and discretionary
spending.
• What does mandatory spending
mean?
• What does discretionary
spending mean?
These expenditures are made
over a fiscal year
• The fiscal year is a 12month accounting period
that is used by
businesses and other
organizations.
• The federal government
begins its fiscal year
every year on October 1.
Fixed or mandatory spending (entitlements, etc.)
• Mandatory spending are
government expenditures that
are fixed by law and can only be
changed by new laws.
• It is different from discretionary
spending.
• Examples of mandatory
spending include Social Security,
Medicare, interest on the
national debt, and food stamps.
Discretionary spending
• Discretionary spending are
expenditures that can be
raised or lowered as a
legislature sees fit.
• Examples of discretionary
spending include military (or
defense) expenditures and
education.
Problems with the Federal Budget
• What are some of the main
problems with the federal
budget?
• 1. Expenses exceed revenues.
• 2. Long-term debt is getting
worse.
• 3. Too much is spent on some
things and not enough on
others. (Opinions will vary.)
What are some possible solutions to the longterm budget deficit?
•Cut expenses
•Increase
revenue (via
tax increases,
etc.)
State and local taxes and expenditures
• State and local budgets reflect
different priorities and
obligations compared to the
federal budget.
• For one thing, they devote a
significant portion of their
budget to education.