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teChapter 12 The Design of the Tax System

A FINANCIAL OVERVIEW OF THE U.S. GOVERNMENT

The government raise money by collecting various taxes. The largest source of revenue for the federal government is the individual income tax.

Marginal tax rate is the tax rate for each additional dollar of income. Marginal tax rate rises as income rises, thus families with higher income pay larger fraction of their income for tax.

TAXES AND EFFICIENCY

Deadweight losses

TAXES AND EQUITY

There are some different ideas on how the tax should be distributed among citizens. One idea is benefits priciple which claims that people should pay taxes based on the benefits they receive from government. Another popular idea is ability-to-pay principle, which states that the amount of taxes should be based on people's ability to pay. The ability-to-pay principle leads to two types of equity: vertical equity and horizontal equity. Vertical equity is the idea that people with greater ability to pay should pay more. Horizontal equity is the idea that people with similar ability to pay should pay equal amount.

Even in the vertical equity, there are 3 kinds of taxes: proportional tax, regressive tax, and progressive tax. Proportional tax is a tax system for which all people pay the same percentage of income. Regressive tax is a tax system for which richer people pay smaller percentage of income. Progressive tax is a tax system for which richer people pay larger percentage of income.

Key Terms budget deficit - excess of government spending budget surplus- excess of government receipts average tax rate- total taxes paid divided by total income marginal tax rate- additional taxes paid for additional dollar of income lump-sum tax- tax with equal amount for every person benefits principle- concept that amount of taxed should be based on the benefits each person receive from government service ability-to-payy principle - concept that the amount of taxes should be based on each person's ability to pay vertical equity - the idea that richer people should pay larger amount of taxes horizontal equity - the idea that people with similar abilities to pay should pay the same amount proportional tax - tax system for which every person pays the same fraction of income regressive tax - tax system for which rich people pay smaller fraction of income progressive tax- tax system for which rich people pay larger fraction of income

Summary