Chapter+12+Emily+K





= = =  = = = = How does a government decide how to tax its citizens? =

= = If you are reading this textbook right now you are probably young enough so that you don't have to worry about paying taxes. Still, you most likely have heard parents and adults in general complaining about how they wish they didn't have to pay taxes. Honestly, how nice would it be to live without taxes and actually get to keep all the money you make? That sounds like a wonderful idea on an individual level, but as a whole, taxes are in fact necessary. If there were no taxes, the government would not have the money to provide the important goods and services that people need, such as schools, parks, libraries, roads, Social Security, national defense...etc. The list goes on. So, you see, the government does need money - quite a lot of money - to provide the society public goods, which, as you learned in the previous chapter, cannot be produced by individual businesses. So in this chapter, you'll learn about the goals of a tax, the negative aspects of a tax, and finally the different kinds of taxes that exist.

= = = = =Goals of the Tax = Because the government collects taxes from all citizens (as in all those who are obliged to pay), and because all citizens living in a country have different standards of living, it is important for the government to keep in mind a couple of qualities that will make the whole taxing system fair and agreeable. These two goals a government must ensure - or at least try its best to ensure - are equality and efficiency.


=**Taxes Lead To** = = =  Tax puts a lot of burden to both the payers and the collectors. Such burden is called **administrative burden**. The tax payers' administrative burden includes the money that they must pay, and also the time and effort spent on computing the taxes. The collectors also share the burden, as they must compute all taxes and make sure that people are paying taxes.
 * Administrative Burden**

As you learned in Chapter 8, a deadweight loss occurs when an incentive is distorted. Because taxes distort incentives, they almost always involve deadweight loss. Let's look at how deadweight losses actually work, with more specific numbers. Two kids, Anna and Alex, want to buy brownies. Anna's value for a pack of brownies is $10, while Alex only puts a $7 value on it. If the cost of the brownies is $5, both will buy the pack of brownies, and Anna will have a $5 consumer surplus and Alex will have a $2 consumer surplus. The total consumer surplus is $7. Then a $3 tax is imposed on the brownies, and now the cost of the brownies rises to $8. Anna still buys the brownies because her value of the brownies is higher than its cost. While she buys the brownies and gets a $2 consumer surplus, Alex chooses not to buy the brownies, now that the new cost has exceeded the value he put on the brownies. And this causes the problem. Anna's consumer surplus has decreased $3 (from $5 to $2), by the amount of the tax, but that money still goes to the government as tax revenue. But what about Alex's loss? His consumer surplus decreased from $2 to nothing, but his loss wasn't balanced out by tax revenue. Thus, deadweight loss arises.
 * Deadweight loss**

= How to tax? =

Tax is more than just the government demanding money from its citizens. It is a complex system that considers many different factors. Many different suggestions and ideas for the "best tax system" have been thrown out to the world, what is there truly one "best" solution? Everyone holds different values, and the opinions of what is the most appropriate tax system depends on the economic status of the opinion holder. In this section, we will explore through some of the basic principles that exists regarding how the tax system should work. Some countries choose one principle as their basis for their tax systems, while other countries favor different principles.

Before you go on further, you must be aware of the basic ways in which people measure taxes. There are two different ways to represent taxes. First, the **average tax rate**, describes the rate of total taxes paid divided by one's total income. Secondly, the **marginal tax rate** represents the rate of extra taxes paid for each additional dollar of one's income. Why are these important? These two different measurements become handy when studying taxes. The average tax rate can tell how much sacrifice a person is making. Marginal tax rate can tell us how much a tax distorts incentives. As you learned in Chapter 1, rational people think at the margin. Thus, the marginal tax rate is used to determine the trade offs that one faces between working and resting. Therefore it is also the marginal tax rate that determines deadweight loss.
 * Average Tax Rate vs. Marginal Tax** **Rate**

  The benefits principle is an idea that argues that people should pay taxes according to how much benefits they receive from the government <span style="color: #000000; font-family: Verdana,Geneva,sans-serif;">. If one person spent five hours in the PC bang (not healthy!) while another only spent one hour, it makes sense that the person who spent more time should pay more. Similarly, the benefits principle says that taxes should be based on how much the person utilized the services provided by the government.
 * <span style="color: #000000; font-family: Verdana,Geneva,sans-serif;">Benefits Principle **

Previously, you have learned about a person's willingness-to-pay. When it comes to taxes, there is an idea based on one's ability-to-pay. According to this principle, <span style="color: #008000; font-family: Verdana,Geneva,sans-serif;">taxes should be levied on each person's ability to pay <span style="color: #000000; font-family: Verdana,Geneva,sans-serif;">. In other words, a person who makes $200 a week and a person who makes $1000 dollars a week should pay different amounts of taxes. To the person who earns $200 a week, a $100 tax is 50% of his weekly income. To the richer man, though, the same amount tax is only 10% of his weekly income. Thus, this principle pushes for everyone to make an "equal sacrifice."
 * Ability-to-pay Principle**

There are two different concepts of equity when it comes to taxing. First, according to the vertical equity, taxpayers with greater ability to pay should pay larger amounts. According to horizontal equity, taxpayers with similar abilities to pay should pay the same amount.
 * Vertical Equity vs. Horizontal Equity**

=<span style="color: #008000; font-family: Verdana,Geneva,sans-serif;">Different Types of Taxes = Now that you've learned about the different principles that lie behind taxes, you are ready to learn the actual different kinds of taxes that exist. Like anything and everything else, each type of tax has its pros and cons. <span style="color: #000000; font-family: Verdana,Geneva,sans-serif;"> **Lump-sum tax** The <span style="color: #008000; font-family: Verdana,Geneva,sans-serif;">most efficient <span style="color: #000000; font-family: Verdana,Geneva,sans-serif;"> of all taxes is the lump-sum tax. This tax calls for all people to pay the exact same amount of tax. This means that, regardless of income, everyone has to pay a set amount of money. Such a tax would be efficient, because since everyone all pays the same amount, there is less calculating to do, and thus less administrative burden. Although very efficient, this tax is not very equitable. It would be unfair for someone who makes $1000 a month and someone who makes three times that to pay the same tax! Proportional tax is a tax where everyone pays the <span style="color: #008000; font-family: Verdana,Geneva,sans-serif;"> same percentage of income as tax <span style="color: #000000; font-family: Verdana,Geneva,sans-serif;">. For instance, all people would be required to pay 10% of their income. This allows more room for equity than the lump-sum tax, because the tax is adjusted according to each person and how much income he or she makes. The regressive tax may be hard to understand at first. It requires that <span style="color: #008000; font-family: Verdana,Geneva,sans-serif;">high-income taxpayers pay a smaller percentage of income than low-income taxpayers <span style="color: #000000; font-family: Verdana,Geneva,sans-serif;">. Supposedly, such a policy intended to trigger a trickle-down effect, which is a theory that when the rich people pay a small amount of taxes, they will spend a lot more money, which will "trickle down" to the rest of the market, and better the economy as a whole. The progressive tax is the most equitable of all taxes. It states that <span style="color: #008000; font-family: Verdana,Geneva,sans-serif;">high-income taxpayers pay a larger percentage of their income than low-taxpayers <span style="color: #000000; font-family: Verdana,Geneva,sans-serif;">. Thus, while a millionaire pays 15%, someone who makes less money may only have to pay 10% of his income as tax. The disadvantage of this tax is that it has the greatest administrative burden, since there is so much calculating to do. Also, this tax has the greatest dead weight loss, because it distorts incentives - the tax motivates people (theoretically and economically) to work less, in order to avoid such a great proportion of income tax! =<span style="color: #000000; font-family: Verdana,Geneva,sans-serif;"> <span style="color: #008000; font-family: Verdana,Geneva,sans-serif;">Conclusion = <span style="font-family: Verdana,Geneva,sans-serif;"><span style="font-family: Verdana,Geneva,sans-serif;">In this chapter, we learned that determining taxes is a very difficult and complicated job. The government that imposes tax wants to be both efficient and equitable, and achieving both is very difficult if not impossible. Many different systems of taxation have been proposed, but no one can conclude one to be the best. If a tax system is fair, it will have some inefficiency. If a tax system is very efficient, it will be unfair to some people. Thus, the process of determining the right tax system deals with finding a good balance between the two important values of efficiency and equity.
 * Proportional tax**
 * Regressive tax**
 * Progressive tax**

===<span style="display: block; font-family: Verdana,Geneva,sans-serif; text-align: center;">Question: Why might it be a good idea to tax consumption rather than income? <span style="font-family: Verdana,Geneva,sans-serif;"> === <span style="font-family: Verdana,Geneva,sans-serif; font-size: 130%;">Answe <span style="font-family: Verdana,Geneva,sans-serif;">r: It would be a good idea to tax the consumption rather than the person's income, because while the system is fair, it can also promote economic growth. If people are taxed on their consumption, many are likely to save more, and this will cause capital formation, which is a positive factor for the economy. Thus, taxing consumption is a good idea if the government wants to promote savings among their citizens.

=<span style="color: #800000; display: block; font-family: Verdana,Geneva,sans-serif; font-size: 150%; text-align: center;"> = **Budget deficit:** government spending is higher than government receipts
 * Budget surplus:** government receipts are higher than government spending
 * Average tax rate:** rate of total taxes paid divided by one's total income
 * Marginal tax rate:** <span style="color: #000000; font-family: Verdana,Geneva,sans-serif;"> rate of extra taxes paid for each additional dollar of one's income
 * Lump-sum tax:** <span style="color: #000000; font-family: Verdana,Geneva,sans-serif;">all people to pay the exact same amount of tax
 * Benefits principle:** <span style="color: #000000; font-family: Verdana,Geneva,sans-serif;">idea that argues that <span style="color: #000000; font-family: Verdana,Geneva,sans-serif;"> <span style="color: #008000; font-family: Verdana,Geneva,sans-serif;">pe <span style="color: #000000; font-family: Verdana,Geneva,sans-serif;">ople should pay taxes according to how much benefits they receive from the governmen <span style="color: #008000; font-family: Verdana,Geneva,sans-serif;">t <span style="color: #000000; font-family: Verdana,Geneva,sans-serif;">
 * Ability-to-pay principle:** <span style="color: #000000; font-family: Verdana,Geneva,sans-serif;"> <span style="color: #000000; font-family: Verdana,Geneva,sans-serif;">taxes should be levied on each person's ability to pay
 * Vertical equity:** <span style="color: #000000; font-family: Verdana,Geneva,sans-serif;"> Taxpayers with greater ability to pay should pay larger amounts
 * Horizontal equity:** <span style="color: #000000; font-family: Verdana,Geneva,sans-serif;"> Taxpayers with similar abilities to pay should pay the same amount
 * Proportional tax:** <span style="color: #000000; font-family: Verdana,Geneva,sans-serif;">tax where everyone pays the <span style="color: #008000; font-family: Verdana,Geneva,sans-serif;"> s <span style="color: #000000; font-family: Verdana,Geneva,sans-serif;">ame percentage of income as ta <span style="color: #008000; font-family: Verdana,Geneva,sans-serif;">x
 * Regressive tax:** <span style="color: #000000; font-family: Verdana,Geneva,sans-serif;"> <span style="color: #000000; font-family: Verdana,Geneva,sans-serif;">high-income taxpayers pay a smaller percentage of income than low-income taxpayers
 * Progressive tax:** <span style="color: #008000; font-family: Verdana,Geneva,sans-serif;">h <span style="color: #000000; font-family: Verdana,Geneva,sans-serif;">igh-income taxpayers pay a larger percentage of their income than low-taxpayer <span style="color: #008000; font-family: Verdana,Geneva,sans-serif;">s <span style="color: #000000; font-family: Verdana,Geneva,sans-serif;">