Microeconomics Lecture 12

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Tax Systems

Key Termsaverage tax rate marginal tax rate lump-sum tax benefits principle ability-to-pay principle vertical equity horizontal equity proportional tax regressive tax progressive tax

Tax SystemTwo Objectives:

Efficient and Equitable Lower costs and fair

Avoiddeadweight loss

administrative burdens !

Efficient? low deadweight loss and low

administrative burdens

Efficient?low deadweight loss

and low administrative burdens

Administrative Burden

It costs time and money to collect

taxes

0

10

20

30

40

50

60

70

80

90

100

0 1 2 3 4 5 6 7 8 9 10

Demand

Supply with no tax

Loss of 160 in surplus !

120 in taxes !

40 to deadweight loss !

25 percent loss to deadweight

Buyer Surplus

Seller Surplus

Tax AnalysisSupply

with 40 SAR tax

Tax on Seller with shift Supply curve up by the amount of the tax

Taxes Tax of 40 SAR

40

40

40

Incentivestaxes distort

change behavior !

Type of TaxesIncome - Earn

Consumption - Spend

Are Taxes Fair?

Benefits !

Ability to Pay

Benefits

You should pay for the benefits you

receive !

Ability

If you are able you should pay more

Tradeoffs

Fair or Efficient?

Income Tax RatesLump-Sum

Proportional Progressive Regressive

Lump Sum

Pay a fixed amount regardless of income

Proportional

Pay a fixed rate regardless of income

Progressive

Pay an increasing rate

as income increases

Regressive

Pay a decreasing rate

as income increases

Rates

Average Marginal

Average

total taxes divided by

income

Marginal

extra tax on the next riyal of

income

10% on first 100 30% on the next 100 then 50% above

Marginal

Tax Rate Income Tax

First 100 10% 100 10

101 to 200 30% 100 30

more than 200 50% 100 50

Summary 300 90

What is the average rate?

What is the marginal rate?

90 ÷ 300 = 30%

50%

30%

Total taxes divided by total income

Rate on the next riyal

0

25

50

75

100

First 100 Second 100 Third 100

Incentives MatterChange the rates

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Change behavior

Laffer Curve

Art Laffer

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

$ Tax

Revenue

No Revenue

Maximum Revenue

Tax Rate

Dropped Top Marginal Income Tax Rate from 70% to 28%

1980 70% Rate

1988 28% Rate

$36 billion - $19 billion

Income above $200,000

$352 billion - $100 billion

Pie x 8.7 Taxes x 4.2

Smaller slice of a larger pie