Chapter+12+-+The+Design+of+the+Tax+System

=Chapter 12: The Design of the Tax System =

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.

Picture: http://smallbusiness.smh.com.au/dotAsset/912443125.jpg

A Financial Overview of The US Government
The United States’ total income is composed of federal, state and local governments. As the economy of the country increases, the cost of taxation also goes up. In other words, the richer the country, the larger the taxation. Let’s look at each realm of the US government precisely.


 * [[image:population_graph.JPG width="452" height="276"]]

The Federal Government** The federal government takes approximately 2/3 of the taxes in the economy.


 * INDIVIDUAL INCOME TAX

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 * PAY ROLL TAX [[image:http://www.premiertaxsolutions.com/images/s_06.jpg width="286" height="157" align="right"]]

A pay roll tax is the tax put on wages, which a firm pays its workers. This revenue, which the government receives, can be called social insurance taxes because the money from pay roll tax is used for Social Security and Medicare. Picture: http://www.premiertaxsolutions.com/images/s_06.jpg


 * COORPORATION TAX

Coorporation tax is the tax that the government puts on to each corporation. This is based on the profit of the corporation.


 * EXCISE TAXES

Excise taxes are taxes on specific goods like gasoline, cigarettes, alcoholic beverages and etc.

Spending of the Federal Government
 The federal government divides the tax money into different categories for spending. Their biggest spending is on Social Security, which is for helping the elderly.

**Transfer Payment:** When a government makes a payment but doesn’t receive any good or service.

The second biggest spending is on national security. Salaries for military men, and military equipment are only some of which the government spends money on.

The third biggest spending is on income security. The government makes payments to the poor. They give money for food, shelter and etc.

Some other categories in which the government makes payments to include Medicare, net interest, and many other services.

 **Budget Deficit:** when the government receipt is smaller than their spending.
 * Budget Surplus: ** when the government receipt is greater than their spending.

The government deals with budge deficit by borrowing money from the public. If the government has budget surplus, they use the money to pay their debts. Picture: http://www.lcsc.edu/library/ILI/Classes/j0144813.jpg

State and Local Government [[image:http://www.cartoonstock.com/lowres/rma0162l.jpg width="294" height="246" align="right"]]
State and local government take 40% of the taxes paid. Sales taxes and property taxes are the two most crucial taxes for the state and local governments. Sales tax is the tax that we pay when we buy goods from stores. Property tax is the tax collected from property owners based on the approximate value of their land and structures.

Unlike the federal government, the states government doesn’t weigh too much on individual income taxation. Instead, they get much of their revenue from the “other” minor category. The other category includes fees for fishing license, tolls from roads and bridges and fares for public transportation. Picture: http://www.cartoonstock.com/lowres/rma0162l.jpg

The Spending of the State and Local Government
They spend most of their money on education. Local governments pay for schools and State governments give some of their money to public universities. Their second biggest spending is payments to the poor. Their third biggest spending is on maintaining the existing roads and building new ones. They also make payments to the minor services such as libraries, police, fire protection and etc. Picture: http://www.campusaccess.com/images/education.jpg

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<span style="color: rgb(255, 11, 0);">Taxes & Efficiency
The goal of a tax system: raise revenue for the government

An efficient and successful tax policy aims to reduce two things: 1. The dead weight loss which is created by the distortion of the decisions which people make 2. The administrative burdens that tax payers face as they follow the tax laws

A good tax system has **small** dead weight losses and **small** administrative burdens.

Picture: http://i141.photobucket.com/albums/r71/blackstocks/tax.jpg

One of the principles of economics says that people respond to incentives. So, if the government puts taxes on a certain good, people stop buying that specific good. In other words, taxes contort incentives and dead weight losses become inevitable. The dead weight loss is created because it changes people’s behavior. Instead of buying and selling goods for their benefits, they act according to tax incentives. **When the total surplus decreases more than the tax revenue, it creates dead weight loss.**

source: http://nthfinancial.blogspot.com/2008/06/gas-tax-and-why-eliminating-it-is-bad.html

The administrative burden includes time that taxpayers spend to fill out tax forms, the time that is needed to organize tax records and the resources that the government needs to use to set up tax laws.

<span style="color: rgb(74, 37, 116);">Marginal Tax Rates VS Average Tax Rates
When talking about efficiency and equity of income taxes, economists look at average tax rate and marginal tax rate.

<span style="color: rgb(232, 2, 2);">**Average tax rate** : total taxes paid / total income <span style="color: rgb(231, 4, 4);">**Marginal tax rate** : the extra amount that tax payers pay for every additional dollar

Marginal tax rate tells us how the tax system changes the workers’ behavior by discouraging them to work extra hours. Thus, marginal tax rate **creates the dead weight loss of an income tax.** Picture: http://banks.com/blogs/irs/wp-content/uploads/2008/02/tax-questions.jpg

<span style="color: rgb(4, 198, 200);">Lump-Sum Taxes
Lump sump tax is a tax that everyone pays the same amount of. It is the **most efficient** tax possible. The reason for this is because

1. does not distort incentives 2. no dead weight loss 3. a person’s decision or action do not change the amount owed

You may ask, “Why do we don’t see lump sum tax as often when it is the most efficient tax?” Well, to answer your question, a lump sum tax takes the same amount from EVERYONE, neglecting the fact that everyone is in different financial stance. Thus, some may view such tax as unfair. In addition, efficiency is only one of the factors of a tax system. There is also equity that we must also take into consideration.

<span style="color: rgb(255, 0, 217);">Taxes and Equity
When talking about taxes, one may ask oneself, “How should the taxes be divided? How do we know whether such system is fair or unfair?” Such questions arise a big dispute among the society.

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Picture: http://www.apfn.org/APFN/TaxReady.jpg <span style="color: rgb(253, 18, 189);"><span style="color: rgb(9, 255, 0);">

=<span style="color: rgb(253, 18, 189);">Summary =
 * The most important taxes for the federal government are individual income taxes and payroll taxes.
 * The most important taxes for state and local governments are sales taxes and property taxes.
 * The equity of a tax system concerns whether the tax burden is distributed fairy among the population.

<span style="color: rgb(3, 109, 15);">Questions For Review
1. What is the most efficient tax and why? 2. Why and how is dead weight loss created in taxes?

Answers
1. Lump sump tax is a tax that everyone pays the same amount of. It is the **most efficient** tax possible. The reason for this is because it does not distort incentives, creates no dead weight loss and a person’s decision or action do not change the amount owed. The reason why we don't see lump sum tax as often in spite of its efficiency is because a lump sum tax takes the same amount from EVERYONE, neglecting the fact that everyone is in different financial stance. Thus, some may view such tax as unfair. Furthermore, efficiency is only one of the factors of a tax system. There is also equity that we must also take into consideration.

2. One of the principles of economics says that people respond to incentives. So, if the government puts taxes on a certain good, people stop buying that specific good. In other words, taxes contort incentives and dead weight losses become inevitable. The dead weight loss is created because it changes people’s behavior. Instead of buying and selling goods for their benefits, they act according to tax incentives. **When the total surplus decreases more than the tax revenue, it creates dead weight loss.**