Chapter+12+The+Desgin+of+the+Tax+System

Ch.12 The Design of the Tax System


=**Table of Contents** = = = 1. Introduction 2. Key Topics and Lectures 3. Conclusion 4. Glossary 5. Summary 6. Citations

__**Introduction**__

Everything has its cost. In order to provide public goods and benefits to the society, the government needs to raise their revenue through taxation. It is through taxation in which the government provides senior homes and national defense, deals with externalities such as air pollution, and aids markets to have better outcomes. So let's look at the tax system more closely. ;)

__**Federal Government**__

- Richer a country is, the more income tax it collects. - GDP (Gross domestic product) measures total income in the economy.
 * Receipts**

INDIVIDUAL INCOME TAX  - The family’s TAX LIABLITY (how much it owes) is based on its total income. - The largest source of revenue for the federal government - __Taxable income__: is computed as total income minus an amount based on the number of dependents - __Marginal Tax Rate__: the tax rate applied to each additional dollar of income.

PAYROLL TAX (SOCIAL INSURANCE TAX)  - a tax on the wages that a firm pays its workers - __Social Security__: an income-support program designed to maintain the living standards of the elderly - __Medicare__: the government health program for the elderly CORPORATE INCOME TAX  - Corporation: a business that is set up as a separate legal entity - The government taxes each corporation based on its profit. - Corporate profits are taxed twice: 1) Once by the corporate income tax (profits) 2) Second by the individual income tax (dividends) EXCISE TAX  - taxes on specific goods like gasoline, cigarettes, and alcohol

SOCIAL SECURITY  - __Transfer Payment__: a government payment not made in exchange for a good or service (mostly to the elderly) <span style="color: #50dc4c; font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 120%;">NATIONAL DEFENSE <span style="color: #000000; font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 120%;"> - includes salaries of soldiers and purchase of military equipment <span style="color: #50dc4c; font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 120%;">INCOME SECURITY <span style="color: #000000; font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 120%;"> - includes transfer payment to the poor <span style="color: #50dc4c; font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 120%;">MEDICARE <span style="color: #000000; font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 120%;"> - the government’s health plan for the elderly <span style="color: #50dc4c; font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 120%;">HEALTH SPENDING <span style="color: #000000; font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 120%;"> - includes Medicaid, the federal health program for the poor, and medical research <span style="color: #50dc4c; font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 120%;">NET INTEREST <span style="color: #000000; font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 120%;"> - __Budget Deficit__: an excess of government spending over government receipts - The government finances a budget deficit by borrowing from the public. - __Budget Surplus__: an excess of government receipts over government spending
 * Spending**


 * __State and Local Government__**

<span style="color: #d20f97; font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 120%;">SALE TAXES <span style="color: #000000; font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 120%;"> - levied as a percentage of the total amount spent at retail stores <span style="color: #d20f97; font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 120%;">PROPERTY TAXES <span style="color: #000000; font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 120%;"> - levied as a percentage of the estimated value of land and structures - paid by property owners <span style="color: #d20f97; font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 120%;">INDIVIDUAL/CORPORATE INCOME TAXES <span style="color: #000000; font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 120%;"> - paid by an individual or a corporation <span style="color: #d20f97; font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 120%;">FUNDS FROM FEDERAL GOVERNMENT <span style="color: #000000; font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 120%;"> - r edistributes funds from high-income states to low-income states OTHERS: · fees for fishing and hunting licenses · tolls from roads · fares for public buses and subways
 * Receipts**


 * Spending**

<span style="color: #50dc4c; font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 120%;">EDUCATION PUBLIC WELFARE <span style="color: #000000; font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 120%;"> - transfer payments to the poor <span style="color: #50dc4c; font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 120%;">HIGHWAYS <span style="color: #000000; font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 120%;"> - building and maintaining


 * __Taxes and Efficiency__**

Watch this video to see what an American politician says about tax system.

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The aim of a tax system is to raise revenue for the government. The two objectives are EFFICIENCY and EQUITY. An efficient tax system raises the same amount of revenue at a SMALLER cost to taxpayers and imposes SMALL DWL and SMALL administrative burdens.

- results when taxes distort the decisions that people make - the inefficiency that a tax creates as people allocate resources according to the tax incentive rather than the true costs and benefits of the goods and services that they buy and sell
 * Deadweight Loss**

- Income tax discourages people from working hard and from saving. - Consumption tax encourages saving and capital formation.
 * Should Income or Consumption Be Taxed?**

__**Administrative Burden**__ - includes time spent filling out tax forms and keeping records for tax - Resources devoted to complying with the tax laws are a type of DWL. · Time and money - This burden can be reduced by simplifying the tax laws. · Difficult because few are eager to give up the loopholes that benefit them.

- total taxes paid divided by total income - more appropriate when gauging the sacrifice made by a taxpayer - measures the fraction of income paid in taxes
 * __Average Tax Rate__**

- extra taxes paid on an additional dollar of income - more appropriate when gauging how much the tax system distorts incentives - measures how much the tax system discourages people from working - determines the DWL of an income tax!
 * __Marginal Tax Rate__**

- a tax that is the same amount for every person - shows the difference btw the average and marginal tax rates - the most EFFICIENT tax - does not distort incentives and does not cause DWL. - unfair for the poor à no equity
 * __Lump-Sum Tax__**

__**Benefits Principle**__ - states that people should pay taxes based on the benefits they receive from government services. - The wealthy should contribute more than the poor because the wealthy benefit more from public services.

__**Ability-to-Pay Principle**__ - states that taxes should be levied on a person according to how well that person can shoulder the burden

- __Vertical Equity__: states that taxpayers with a greater ability to pay taxes should contribute a larger amount 1) __Proportional Tax__: high income and low income taxpayers pay the same fraction of income 2) __Regressive Tax__: high income taxpayers pay a smaller fraction of their income than do low income taxpayers 3) __Progressive Tax__: high income taxpayers pay a larger fraction of their income than do low income taxpayers 4) __Horizontal Equity__: states that tax payers with similar abilities to pay should contribute the same amount - Marriage Tax o Marriage affects the tax liability of a couple in that tax law treats a married couple as a single taxpayer. o When a couple gets married, they stop paying taxes as individuals and start paying taxes as a family. o If each has a similar income, their total tax liability rises when they get married.

__Flat Tax:__ a tax system with a constant, one marginal rate in contrast to progressive tax that may vary according to income levels __Tax Incidence__: the study of who bears the burden of taxes - central to evaluating tax equity __Flypaper Theory__ · The burden of a tax, like a fly on flypaper, sticks wherever it first lands. __Corporate Income Tax__ - causes the price of goods to rise - causes the wages of the workers to fall

<span style="color: #000000; font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 120%;">__Summary__ - Income taxes and payroll taxes raise the most revenue for the federal government. - Sales taxes and property taxes raise the most revenue for the state and local governments. - The distribution of tax burdens is not the same as the distribution of tax bills.

<span style="color: #000000; font-family: 'Trebuchet MS',Helvetica,sans-serif; font-size: 120%;">__Citation__

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