TAXES: The main source of government revenue

TAXES: The main source of government revenue

The Economics of Taxation

The Economics of Taxation

In addition to creating revenue for the government, taxes also impact the economy in the following ways:

Resource allocation - if taxes are too high, supply will decrease and /or prices will increase causing a shift in the allocation of land, labor and capital.

Behavior adjustment - sin taxes, such as those placed on cigarettes attempt to change a person’s behavior

Productivity and Growth - if taxes are too high, there is less incentive for people or businesses to continue to grow. Why earn more if most of it is taken away in higher taxes?

In addition to creating revenue for the government, taxes also impact the economy in the following ways:

Resource allocation - if taxes are too high, supply will decrease and /or prices will increase causing a shift in the allocation of land, labor and capital.

Behavior adjustment - sin taxes, such as those placed on cigarettes attempt to change a person’s behavior

Productivity and Growth - if taxes are too high, there is less incentive for people or businesses to continue to grow. Why earn more if most of it is taken away in higher taxes?

Incidence of a TaxIncidence of a Tax

Who bears the final burden of this tax?

If there is a relatively inelastic demand curve the burden can be shifted to the consumer.

It there is a relatively elastic demand curve, the producer will absorb the tax.

Who bears the final burden of this tax?

If there is a relatively inelastic demand curve the burden can be shifted to the consumer.

It there is a relatively elastic demand curve, the producer will absorb the tax.

To be effective Taxes must meet the following

criteria:

To be effective Taxes must meet the following

criteria:

EQUITYIs this tax fair?

SIMPLICITYIs this tax easy to understand?

EFFICIENCYIs this tax easy to administer?

Does this tax generate enough money?

CRITERIA FOR TAXES

EQUITYIs this tax fair?

SIMPLICITYIs this tax easy to understand?

EFFICIENCYIs this tax easy to administer?

Does this tax generate enough money?

CRITERIA FOR TAXES

TWO PRINICPLES of TAXATION

TWO PRINICPLES of TAXATION

“Who pays What” is based on two principles:

Benefit Principle - The more you benefit from something, the more you should pay. Taxes on gasoline

Ability to Pay - The more you make the more you should pay.

“Who pays What” is based on two principles:

Benefit Principle - The more you benefit from something, the more you should pay. Taxes on gasoline

Ability to Pay - The more you make the more you should pay.

Types of TaxesTypes of Taxes

Taxes are classified according to the ay in which the tax burden changes as income changes.

Proportional Tax Progressive Tax Regressive Tax

Taxes are classified according to the ay in which the tax burden changes as income changes.

Proportional Tax Progressive Tax Regressive Tax

Proportional TaxesProportional Taxes

Regardless of Income, the same tax rate is imposed upon everyone. Another term for a proportional tax is a flat tax.

If there is a 20% flat tax, how much do you pay in taxes if you earn $10,000? What if you earn $100,000?

Note as a person’s income increases, the percentage of total income paid in taxes remains the same.

Property Tax is a proportional tax.

Regardless of Income, the same tax rate is imposed upon everyone. Another term for a proportional tax is a flat tax.

If there is a 20% flat tax, how much do you pay in taxes if you earn $10,000? What if you earn $100,000?

Note as a person’s income increases, the percentage of total income paid in taxes remains the same.

Property Tax is a proportional tax.

Proportional TaxProportional Tax

Income

10,000 50,000 100,000

Tax Rate

40%

20%

10%

Progressive TaxProgressive Tax People with higher incomes pay a higher

percentage in taxes. Federal and State income tax are progressive taxes.

People with higher incomes pay a higher percentage in taxes. Federal and State income tax are progressive taxes.

INCOME Amount Paid in Taxes

Amount Paid as a percentage of Income

$10,000 $1,000 10%

$50,000 $ 10,000 20%

$100,000 $ 30,000 30%

Progressive TaxProgressive Tax

Income

10,000 50,000 100,000

Tax Rate

40%

20%

10%

Regressive TaxesRegressive Taxes The lower the income the higher

percentage paid in taxes. Sales tax is an example of a regressive tax.

Assume two families paid $1000 in sales tax by the end of the year. Which family spent a higher percent of their income on taxes?

The lower the income the higher percentage paid in taxes.

Sales tax is an example of a regressive tax. Assume two families paid $1000 in sales tax by the end of the year. Which family spent a higher percent of their income on taxes?

Income Amount paid in taxes

Amount paid in taxes as a percentage of their income.

$10,000 $1000.00 10%

$50,000 $1000.00 5%

Regressive TaxRegressive Tax

Income

10,000 50,000 100,000

Tax Rate

40%

20%

10%

FEDERAL TAXESFEDERAL TAXESAmendment 16 gives Congress the power to lay and collect taxes. Federal Income Taxes are due April 15. In 2006, Tax Freedom Day was April 26, this is day you will have earned enough money to pay for all you federal, state and local taxes. In 2004, an estimated 45% of the federal budget came from individual income tax.

Income TaxIncome Tax

Individual income taxes are paid over time through a payroll withholding system (just look at your paycheck). By April 15, you must file a tax return. Any difference in the amount paid compared to the amount owed is settled at this time.

From an economist’s point of view, is it better to owe money to the IRS or receive a refund check? WHY?

Individual income taxes are paid over time through a payroll withholding system (just look at your paycheck). By April 15, you must file a tax return. Any difference in the amount paid compared to the amount owed is settled at this time.

From an economist’s point of view, is it better to owe money to the IRS or receive a refund check? WHY?

More Federal TaxesMore Federal Taxes FICA - Federal Insurance Contributions Act

Social Security and Medicare Corporate Income Tax - As a separate

legal entity, corporations are taxed. Excise Tax - tax on the manufacture or sale

of selected items Estate Tax - tax (18-50%) on the transfer

of property upon a death. As of 2006, estates worth less than 2 million dollars are exempt.

Gift Tax - Tax on money donations, paid by the person donating.

Customs Duties: Tax on imported goods. Exported goods may not be taxed.

FICA - Federal Insurance Contributions Act Social Security and Medicare

Corporate Income Tax - As a separate legal entity, corporations are taxed.

Excise Tax - tax on the manufacture or sale of selected items

Estate Tax - tax (18-50%) on the transfer of property upon a death. As of 2006, estates worth less than 2 million dollars are exempt.

Gift Tax - Tax on money donations, paid by the person donating.

Customs Duties: Tax on imported goods. Exported goods may not be taxed.

State Taxes and Local Taxes

State Taxes and Local Taxes

Intergovernmental Revenues - transfer of money from the federal government

Sales Tax Employee

Retirement Contributions

Individual Income Tax

Intergovernmental Revenues - transfer of money from the federal government

Sales Tax Employee

Retirement Contributions

Individual Income Tax

Intergovernmental Revenues -from state level

Property Tax Public Utility or

State owned liquor stores

Sales Tax - this varies from city to city!

Intergovernmental Revenues -from state level

Property Tax Public Utility or

State owned liquor stores

Sales Tax - this varies from city to city!