1

Sources of Government Revenue

Chapter 9 pages 208 235

The Economics of Taxation

Economic Impact of Taxes
Resource Allocation Decrease in S, if D remains unchanged, raises the rice People react to higher price by buying less

Supply and Demand

P

Price

0 Product (measurement)

Behavior adjustment Sin tax a relatively high tax designed to raise revenue as well as reduce consumption of a socially undesirable product Reduction or elimination of a tax can encourage behavior

117186228.doc 24 Jan 08

Supply and Demand

P

Price

0 Product (measurement)

Productivity and Growth Workers may lose incentive to work Businesses may not expand production Households may save less thus hindering Investment

Criteria for Taxes

Equity fairness Tax loopholes exceptions or oversights in the tax law that allow some people and businesses to avoid paying certain taxes Simplicity written so that both the taxpayer and the tax collector can understand them Efficiency relatively easy to administer and reasonably successful as a revenue-generating device

117186228.doc 24 Jan 08

Two Principles of Taxation

Benefit Principle those who benefit from government services should be the ones to pay for them and people should pay taxes in proportion to the amount of services or benefits they receive. Ability-to-pay Principle people should be taxed according to their ability to pay, regardless of the benefits they receive

Types of Taxes
Proportional Tax imposes the same percentage rate of taxation on everyone regardless of income; the average tax rate is constant regardless of income Progressive Tax imposes a higher percentage rate of taxation on persons with high incomes; a marginal tax rate is usually employed Regressive Tax imposes a higher percentage rate of taxation on low incomes than on high incomes Average Tax Rate total taxes paid divided by total income; tax paid as a percentage of income

The US Federal Tax System

Individual Income Taxes
16th Amendment to the US Constitution (1913) gave US Congress power to tax incomes Individual Income Tax - a tax on peoples earnings Payroll withholding system employer withholds taxes from employee and sends to the IRS (Internal Revenue Service); employee files tax return by 15 April to settle accounts with the government

117186228.doc 24 Jan 08

4 Progressive Income Tax

-[if gte IE]> <![endif]- ->

2005 Tax Rate Schedules

Note: These tax rate schedules are provided so that you can compute your estimated tax for 2005. To compute your actual income tax, please see the instructions for 2005 Form 1040, 1040A, or 1040EZ as appropriate when they are available.

Schedule X Single
If taxable income is over-- But not over-$0 $7,300 $29,700 $71,950 $150,150 $326,450 $7,300 $29,700 $71,950 $150,150 $326,450 no limit The tax is: 10% of the amount over $0 $730 plus 15% of the amount over 7,300 $4,090.00 plus 25% of the amount over 29,700 $14,652.50 plus 28% of the amount over 71,950 $36,548.50 plus 33% of the amount over 150,150 $94,727.50 plus 35% of the amount over 326,450

Schedule Y-1 Married Filing Jointly or Qualifying Widow(er)

If taxable income is over-- But not over-$0 $14,600 $59,400 $119,950 $182,800 $326,450 $14,600 $59,400 $119,950 $182,800 $326,450 no limit The tax is: 10% of the amount over $0 $1,460.00 plus 15% of the amount over 14,600 $8,180 plus 25% of the amount over 59,400 $23,317.50 plus 28% of the amount over 119,950 $40,915.50 plus 33% of the amount over 182,800 $88,320.00 plus 35% of the amount over 326,450

Schedule Y-2 Married Filing Separately

If taxable income is over-- But not over-$0 $7,300 $29,700 $59,975 $91,400 $163,225 $7,300 $29,700 $59,975 $91,400 $163,225 no limit The tax is: 10% of the amount over $0 $730 plus 15% of the amount over 7,300 $4,090 plus 25% of the amount over 29,700 $11,658.75 plus 28% of the amount over 59,975 $20,457.75 plus 33% of the amount over 91,400 $44,160.00 plus 35% of the amount over 163,225

Schedule Z Head of Household

If taxable income is over-- But not over-$0 $10,450 $39,800 $102,800 $166,450 $326,450 $10,450 $39,800 $102,800 $166,450 $326,450 no limit The tax is: 10% of the amount over $0 $1,045 plus 15% of the amount over 10,450 $5,447.50 plus 25% of the amount over 39,800 $21,197.50 plus 28% of the amount over 102,800 $39,019.50 plus 33% of the amount over 166,450 $91,819.50 plus 35% of the amount over 326,450

117186228.doc 24 Jan 08

Indexing an upward revision of tax brackets to keep workers from paying higher taxes just because of inflation.

FICA Taxes (Federal Insurance Contributions Act)

A tax levied on both employers and employees for Social Security (pension scheme) and Medicare (health-care program). Medicare is open to all senior citizens regardless of income. Social Security is only received by those who have paid into the system and meet other minimal requirements.
2007 FICA Tax Rates Tax
Social Security Medicare

Tax Rate
6.20% 1.45%

Maximum Wage Base

$97,500 No limit

Maximum Tax
$6,045 No ceiling

12.4% FICA for self-employed 2.9% Medicare for self-employed

Corporate Income Tax

Corporate Income Tax the tax a corporation pays on its profits
2007 Corporate Tax Rates Rate
15% 25% 34% 39% 34% 35% 38% 35%

Taxable Income
$0-50,000 50,001-75,000 75,001-100,000 100,001-335,000 335,001-10,000,000 10,000,001-15,000,000 15,000,001-18,333,333 Over 18,333,333

*Personal service corporations pay a flat 35%

Other Federal Taxes

Excise Taxes a tax on the manufacture or sale of certain items, such as gasoline and liquor; placed on domestic goods; tend to be regressive Luxury Tax an excise tax on a luxury good or service (a good or service whose demand increases faster than income when income grows) Estate Tax the tax the government levies on the transfer of

117186228.doc 24 Jan 08

6 property (assets) when a person dies Gift Tax a tax on donations of money or wealth and is paid by the person who makes the gift Tariffs (customs duties) a charge levied on goods brought in from other countries (imports) User fees charges levied for the use of a good or service (e.g. national park entrance fees)

State and Local Tax Systems

Intergovernmental revenues funds collected by one level of government that are distributed to another level of government for expenditures

US State Government Revenues

Four Main Sources (ordered by amount collected): 1. Intergovernmental revenues - largest source and funds are used for welfare, education, highways, health, and hospitals among others 2. Sales Tax a general tax levied on consumer purchases of nearly all products; many states do not tax necessities such as food and drugs; a regressive tax 3. Employee Retirement Contributions state retirement plans 4. Individual Income Taxes

US Local Government Revenue Sources

Four Main Sources (ordered by amount collected): 1. Intergovernmental revenues received from State Governments; largest source and funds are used for education and public welfare Property Tax a tax on real property and tangible and intangible property Real Property includes real estate, buildings, and anything
117186228.doc 24 Jan 08

2.

7 permanently attached such as elevators and central air conditioners; raises the most revenue Tangible Personal Property all tangible items of wealth not permanently attached to land or buildings such as automobiles, furniture, farm animals, the stock of goods in retail stores, and clothing Intangible Personal Property property with an invisible value and is represented by paper documents such as a stock, bond, patent, or check 3. Utility and Liquor Store Income Earnings of public utilities and state-owned liquor stores 4. City and town sales taxes

Current Tax Issues

Incidence of a tax
Who actually bears the burden of a tax, the consumer or the producer?

Incidence of a Tax
P

117186228.doc 24 Jan 08

Price

0 Good A

Incidence of a Tax
P

Price

0 Good A

The Value Added Tax

117186228.doc 24 Jan 08

9 VAT (Value Added Tax) a tax placed on the value that manufacturers add at each stage of production; a tax on consumption instead of income

Advantages of a VAT 1. Hard to avoid because tax collector levies it on the total amount of sales minus the cost of inputs 2. Incidence of the tax is widely spread 3. Tax is not visible to the consumer because it has been built in to the price 4. Easy to collect since businesses already make regular tax payments to the government 5. A relatively small VAT can raise a large amount of revenue

Disadvantages of VAT 1. 2. Tends to be invisible to consumers Would compete with already existing US sales taxes

Tax Terminology
117186228.doc 24 Jan 08

10 (Chapter 9 pages 208-235) Income Tax - a tax on peoples earnings Proportional Tax imposes the same percentage rate of taxation on everyone regardless of income; the average tax rate is constant regardless of income Progressive Tax imposes a higher percentage rate of taxation on persons with high incomes; a marginal tax rate is usually employed Regressive Tax imposes a higher percentage rate of taxation on low incomes than on high incomes Average Tax Rate total taxes paid divided by total income; tax paid as a percentage of income VAT (Value Added Tax) a tax placed on the value that manufacturers add at each stage of production Sales Tax a general tax levied on consumer purchases of nearly all products Corporate Income Tax the tax a corporation pays on its profits Excise Taxes a tax on the manufacture or sale of certain items, such as gasoline and liquor; placed on domestic goods Estate Tax the tax the government levies on the transfer of property (assets) when a person dies Gift Tax a tax on donations of money or wealth and is paid by the person who makes the gift Tariffs (customs duties) a charge levied on goods brought in from other countries (imports) Luxury Tax an excise tax on a luxury good or service (a good or service whose demand increases faster than income when income grows Capital Gains Tax tax on profits made from the sale of an asset held for 18 months Tax for a government sponsored pension a tax to provide an income after a person retires

117186228.doc 24 Jan 08

11

Health Care Tax a tax to provide health and medical care for citizens Property Tax a tax on real property and tangible and intangible property Real Property includes real estate, buildings, and anything permanently attached such as elevators and central air conditioners Tangible Personal Property all tangible items of wealth not permanently attached to land or buildings such as automobiles, furniture, farm animals, the stock of goods in retail stores, and clothing Intangible Personal Property property with an invisible value and is represented by paper documents such as a stock, bond, patent, or check User fees charges levied for the use of a good or service

117186228.doc 24 Jan 08