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Personal Income Tax Basic Structure What is fair? People with equal incomes should pay equal taxes? People should pay in proportion to the benefits they receive Is progressivity fair? Do rich people receive proportionally greater benefits than poor people? Property rights Are there better public schools in rich neighborhoods? Better public infrastructure? Better quality environment? What is Income? Money value of the net increase in an individual’s power to consume during a period How much you consume this period without reducing your ability to consume in future periods Are your job benefits income? Are unrealized capital gains income? Is income in kind income? Housework and child care? Imputed rent? My garden and furniture? Business expenses Capital investments and depreciation Three martini lunches Excludable income Interest on state and local bonds Why does government allow this? Is it efficient? Potential for arbitrage Capital gains Why a deferred rate? Why a lower rate? Earned vs. unearned income Double taxation What about inflation? Some types of savings Does it stimulate savings? Exemptions and Deductions Exemptions and progressivity Are deductions fair and efficient? Relative prices Mortgage deductions and land speculation State and local taxes Why have all these deductions? Tax simplification Importance of transaction costs 1040 form with 127 pages 1,300,000 words in tax code 1986 tax code changes 2001 tax code changes Sunset provisions AMT Tax Reform Flat tax Green taxes/Land taxes Tobin Tax Wealth taxes Estate taxes Deficit Finance Definitions Deficit– flow variable measured over time (usually 1 year), difference between expenditures and revenue On-budget deficit: ignores social security and postal service Off-budget deficit: social security and postal service Unified budget deficit: the two together Surplus– an historical curiosity, no longer relevant Debt– stock variable measured at a point in time, sum of all accumulated deficits Facts and figures Federal Debt currently about 7.3 trillion How big is a trillion? ~ 3 trillion held by government ~0.6 trillion held by Fed ~1.7 trillion held by foreigners Per capita Fed debt about $24,910 Rate of increase about $1.73 billion per day, or $2000 per person per year State and local debt ~$1.4 trillion Federal deficit Year 20 20 20 20 20 20 20 20 20 19 19 19 19 19 19 19 19 19 19 19 19 19 19 1 3 1 3 1 3 1 3 1 3 1 3 1 3 1 3 1 3 1 3 1 3 1 93 93 94 94 95 95 96 96 97 97 98 98 99 99 00 00 01 01 02 02 03 03 04 - $billions Total Debt 4,000.00 3,500.00 3,000.00 2,500.00 2,000.00 1,500.00 1,000.00 500.00 0.00 Debt, deficits and inflation Inflation erodes value of debt 2% inflation x 7 trillion debt = 140 billion “inflation tax” US could simply print money to pay off the debt with inflation tax Capital accounts vs. current accounts Debt does not distinguish between consumption and investment Should tangible assets be included? Privatization and the deficit What would be the net result if we account for natural resource loss? Developing countries US Why doesn’t the government distinguish? Should obligations be included? ~ 9 trillion in social security obligations ~ 6 trillion in Medicare obligations ~1.75 trillion in pension obligations Burden of Debt Interest payments = ~10% of federal expenditures Is it spent on consumption or investment? If rate of return on investment is higher than interest, no problem Is it internal? Does internal debt impose a burden on future generations? Studies suggest that debt now = higher future taxes, transfer of resource from future to present Crowding out What happens to interest rates when demands for loans increase? What is the impact on business? What is the impact on foreign countries holding US dollar debt? Reagan deficits and Latin American Debt crisis 19 93 19 - 1 93 19 - 3 94 19 - 1 94 19 - 3 95 19 - 1 95 19 - 3 96 19 - 1 96 19 - 3 97 19 - 1 97 19 - 3 98 19 - 1 98 19 - 3 99 19 - 1 99 20 - 3 00 20 - 1 00 20 - 3 01 20 - 1 01 20 - 3 02 20 - 1 02 20 - 3 03 20 - 1 03 20 - 3 04 -1 percent of foreign to total privately held debt 0.6 0.5 0.4 0.3 0.2 0.1 0 percent of foreign to total debt Why do foreigners assume US debt? It is safe Dollar is strong Risk adjusted interest rates are competitive What else do you do with a trade surplus? What happens if dollar gets weak? Foreigners will not buy bonds and will sell dollars What does this do to the dollar? Interest rates must be raised to attract money What does this do to business? Tax or Borrow? Really a question of tax now or tax later? Beneficiary pays principle Intergenerational equity issue Keynesian answer: Borrow when economy is weak, accumulate debt Tax when economy is booming, pay off debt