CHAPTER+12-+THE+DESIGN+OF+THE+TAX+SYSTEM

The Design of the Tax System  - Taxes use up about a third of the average American’s income - The benefits of government come with costs - How a tax on a good affects supply and demand for that good - How the burden of a tax is shared by buyers and sellers depending on the elasticity of supply and demand - How taxes cause DWL n The reduction in consumer and producer surplus resulting from a tax exceeds the revenue raised by the government - The tax system should be both efficient and equitable • The U.S. federal government collects about **two-thirds** of the taxes in our economy. • The largest source of revenue for the federal government is the **individual income tax**. • Individual Income Taxes • The //marginal tax rate // is the tax rate applied to each additional dollar of income. • __ Higher __ -income families pay a __larger__ percentage of their income in taxes. • __ Payroll Taxes __ : tax on the wages that a firm pays its workers. • ** Social Insurance Taxes ** : taxes on wages that is earmarked to pay for Social Security and Medicare. • __ Excise Taxes __ : taxes on specific goods like gasoline, cigarettes, and alcoholic beverages. • Federal Government Spending • Government spending includes transfer payments and the purchase of public goods and services. • Transfer payments are government payments not made in exchange for a good or a service. • Transfer payments are the **largest** of the government’s expenditures. • Budget Surplus • A //budget surplus // is an excess of government receipts over government spending. • Budget Deficit • A //budget deficit // is an excess of government spending over government receipts. • Financial Conditions of the Federal Budget • A **budget deficit** occurs when there is an excess of government spending over government receipts. • Government finances the deficit by borrowing from the public. • A **budget surplus** occurs when government receipts are greater than government spending. • A budget surplus may be used to reduce the government’s outstanding debts. • State and local governments collect about **40** percent of taxes paid. TAXES AND EFFICIENCY • Policymakers have two objectives in designing a tax system... – Efficiency – Equity • One tax system is more //efficient // than another if it raises the same amount of revenue at a smaller cost to taxpayers. • An //efficient // tax system is one that imposes small deadweight losses and small administrative burdens. • • The Cost of Taxes to Taxpayers • The tax payment itself • Deadweight losses • Administrative burdens • Because taxes distort incentives, they entail deadweight losses. • The deadweight loss of a tax is the __reduction of the economic well-being of taxpayers in excess of the amount of revenue raised by the government.__ • Complying with tax laws creates additional deadweight losses. • Taxpayers lose additional time and money documenting, computing, and avoiding taxes over and above the actual taxes they pay. • The administrative burden of any tax system is part of the inefficiency it creates. • The //average tax rate // is total taxes paid divided by total income. • The //marginal tax rate // is the extra taxes paid on an additional dollar of income. • • A //lump-sum tax // is a tax that is the same amount for every person, regardless of earnings or any actions that the person might take. -How should the burden of taxes be divided among the population? -How do we evaluate whether a tax system is fair? • Principles of Taxation – Benefits principle – Ability-to-pay principle • The //<span style="color: rgb(51, 153, 102);">benefits principle // is the idea that people should pay taxes based on the benefits they receive from government services. • An example is a gasoline tax: • Tax revenues from a gasoline tax are used to finance our highway system. • People who drive the most also pay the most toward maintaining roads. • • The //<span style="color: rgb(51, 153, 102);">ability-to-pay principle // is the idea that taxes should be levied on a person according to how well that person can shoulder the burden. • The ability-to-pay principle leads to two corollary notions of equity. • Vertical equity • Horizontal equity • //<span style="font-family: Arial; color: rgb(51, 153, 102);">Vertical equity // is the idea that taxpayers with a greater ability to pay taxes should pay larger amounts. • For example, people with higher incomes should pay more than people with lower incomes. • Vertical Equity and Alternative Tax Systems • A //<span style="color: rgb(51, 153, 102);">proportional tax // is one for which high-income and low-income taxpayers pay the same fraction of income. • A //<span style="color: rgb(51, 153, 102);">regressive tax // is one for which high-income taxpayers pay a smaller fraction of their income than do low-income taxpayers. • A //<span style="color: rgb(51, 153, 102);">progressive tax // is one for which high-income taxpayers pay a larger fraction of their income than do low-income taxpayers. • Horizontal Equity • //<span style="font-family: Arial; color: rgb(51, 153, 102);">Horizontal equity // is the idea that taxpayers with similar abilities to pay taxes should pay the same amounts. • ** For example **, two families with the same number of dependents and the same income living in different parts of the country should pay the same federal taxes. • • Marriage affects the tax liability of a couple in that tax law treats a married couple as a single taxpayer. • When a couple gets married, they stop paying taxes as individuals and start paying taxes as a family. • If each has a similar income, their total tax liability rises when they get married. • The difficulty in formulating tax policy is balancing the often conflicting goals of efficiency and equity. • The study of who bears the burden of taxes is central to evaluating tax equity. • This study is called tax incidence. • Flypaper Theory of Tax Incidence • According to the flypaper theory, the burden of a tax, like a fly on flypaper, sticks wherever it first lands.
 * The Federal Government **
 * State and Local Government **
 * Deadweight Losses **
 * Administrative Burdens **
 * Marginal Tax Rates versus Average Tax Rates **
 * Lump-Sum Taxes **
 * Benefits Principle **
 * Ability-to-Pay Principle **
 * CASE STUDY: Horizontal Equity and the Marriage Tax **
 * Tax Incidence and Tax Equity **

<Summary>

• The U.S. government raises revenue using various taxes. • 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. • Equity and efficiency are the two most important goals of the tax system. • The efficiency of a tax system refers to the costs it imposes on the taxpayers. • The equity of a tax system concerns whether the tax burden is distributed fairly among the population. • According to the benefits principle, it is fair for people to pay taxes based on the benefits they receive from the government. • According to the ability-to-pay principle, it is fair for people to pay taxes on their capability to handle the financial burden. • The distribution of tax burdens is not the same as the distribution of tax bills. • Much of the debate over tax policy arises because people give different weights to the two goals of efficiency and equity. media type="youtube" key="Nc2kngJ1dZo" height="344" width="425"