Chapter+12-+The+Design+of+the+Tax+System+(09-10)

The Design of the Tax System

Introduction: In the previous chapters, we have learned about the effect of tax, the reduction in the quantity sold, and how the burn of tax is shared among the buyers and sellers. In this chapter, we are going to learn more about how the tax system is designed. Before we try to learn about the design of tax system, it is esstional to know the basic facts about how the U.S. government raises and spends money. Moreover, we will learn about the efficiency and equity about the tax system.

** The Federal Government ** As nation gets richer, the government. typically takes a larger share of income in taxes. About 2/3 of all taxes are collected by the federal government//. // // Receipts // are the amount of money or r**evenue that the federal government gets**. One of the largest source of revenue is the **individual income tax**. computed with **marginal tax rate.** Because marginal tax rate increases and individual income increases, families with higher income pay more. Other than individual income tax, the taxes in the receipt includes: In conclusion, the federal government revenue is collected by taxes including individual income tax, payroll tax, social insurance tax, and excise taxes.
 * Glossary:**
 * **ability-to-pay principle** || the idea that taxes should be levied on a person according to how well that person can shoulder the burden ||
 * **average tax rate** || total taxes paid divided by total income ||
 * **benefits principle** || the idea that people should pay taxes based on the benefits they receive from government services ||
 * **budget deficit** || an excess of government spending over government receipts ||
 * **budget surplus** || an excess of government receipts over government spending ||
 * **horizontal equity** || the idea that taxpayers with similar abilities to pay taxes should pay the same amount ||
 * **lump-sum tax** || a tax that is the same amount for every person ||
 * **marginal tax rate** || the extra taxes paid on an additional dollar of income ||
 * **progressive tax** || a tax for which high-income taxpayers pay a larger fraction of their income than do low-income taxpayers ||
 * **proportional tax** || a tax for which high-income and low-income taxpayers pay the same fraction of income ||
 * **regressive tax** || a tax for which high-income taxpayers pay a smaller fraction of their income than do low-income taxpayers ||
 * **vertical equity** || the idea that taxpayers with a greater ability to pay taxes should pay larger amounts ||
 * Every year at April 15th, every American family fill out tax form to determine how much tax they owe to the government. The **tax liability** (how much it owes) is based on **total income** including:
 * wages from working
 * interest on savings
 * dividends from corporations in which it owns shares
 * profits from any small business it operates
 * etc
 * **payroll tax**
 * tax on wages that a firm pays its workers
 * **social insurance tax**
 * revenue for these taxes are for social security and medicine
 * **corporate income tax**
 * corporation means business that is set up as a separate legal entity
 * government taxes each corporate based on its profit
 * corporate income tax is taxed twice including:
 * corporate income tax
 * individual income tax
 * **excise taxes**
 * taxes on specific goods including:
 * gasoline
 * cigarette
 * alcohol

// Spending // are the amount of money **that the federal government spends**. One of the largest source of revenue is the **social security**. Other than social security, federal government spends includes: In conclusion, the federal government spending is combination of social security, national defense, income security, net interest, medicare, health and others.
 * This is mostly the **transfer payments** to the elderly, which means a government payment not made in exchange for a good or service.
 * **National defense**
 * fluctuates depends on international tension
 * **Income security**
 * transfer payments to poor families
 * **Medicine**
 * governments' health plan for the elderly
 * **Health**
 * Medicaid
 * health program for poor
 * medical research
 * **Net interest**
 * gov. borrows money from public
 * [[image:arrow.jpg width="16" height="21"]]indebted, [[image:arrow.jpg width="16" height="21"]]pay interest
 * **"other"**
 * less expensive functions of gov.
 * federal court
 * space program

When spending exceeds receipts, the government is said to run budget surplus When receipts exceed spending, the government is said to run budget deficit

About 40% of the taxes are collected by the state and local government. // Receipts // are the amount of money or r**evenue that the state and local government gets**. The two most important taxes for state and local governments are **sales taxes** and **property taxes.**
 * State and Local Government **
 * **Sales tax**
 * Sales taxes are levied as a percentage of the total amount spent at retail stores
 * Thus, when a consumer buys something, the extra payment for the storekeeper to pay to the government is included
 * **Property tax**
 * Property taxes are levied as a percentage of the estimated value of land and structures
 * These taxes are paid by the property owners
 * **Corporate** **income tax**
 * These taxes are similar to federal income taxes
 * government taxes each corporate based on its profit
 * **Individual income tax**
 * **From federal government**
 * State and local governments receive substantial funds from the federal government
 * **Other**
 * fishing & hunting license
 * tolls
 * fares for public buses & subways

In conclusion, the state and local government spending is combination of sales tax, property tax, corporate income tax, individual income tax, from federal government, and others.

// Spending // are the amount of money **that the federal government spends**. One of the largest source of revenue is the **social security**.
 * **Education**
 * Local governments pay for the public schools from kindergarten to high school and public universities
 * **Public welfare**
 * Include transfer payments to the poor
 * Include federal programs that are administrated by state and local governments
 * **Highways**
 * Include the building of new roads and the maintenance of existing ones
 * **Other**
 * Libraries
 * Police
 * Garbage removal
 * Park
 * Snow removal

In conclusion, the state and local government spending is combination of education, public welfare, highways, and others.



The aim of a tax system is to raise revenue for the government. Thus, in designing the tax systems the policymakers have two objectives: efficiency and equity. However, taxes impose two other costs: Dead weight Losses Administrative Burden
 * Taxes and efficiency **
 * DWL result when the taxes distort the decision that people make[[image:300px-Deadweight-loss-price-ceiling.svg.png width="359" height="359" align="right" caption="Source: http://www.answers.com/topic/deadweight-loss"]]
 * The administrative burdens that taxpayers bear as they comply with the tax laws
 * If the government taxes a good, the consumers will buy less of that good because they will lose incentives
 * Thus, taxes entail DWL
 * Dead weight loss is the inefficiency that a tax creates as people allocate resources according to the tax incentives rather than the true costs and benefits of the goods and services that they buy and sell
 * The burden includes the time spent before April 15th to fill out the tax form, time spent throughout all the years to keep in track, and the resources the government has to use to enforce the tax laws
 * But many taxpayer hire tax lawyers and accountants to help them
 * legal tax avoidance
 * abuse some of the detailed provisions of the tax code
 * congressional mistakes
 * chosen to give special treatment to specific types of behavior
 * Marginal Tax Rates vs. Average Tax Rates **

When discussing the efficiency and equity of income taxes, we distinguish the two notions of tax rates: >> > ** Taxes and Equity **
 * average tax rate
 * total taxes paid divided by total income
 * sacrifice of taxpayer
 * marginal tax rate
 * extra taxes paid on an additional dollar of income
 * ex.
 * gov. 20% of first $50,000,50% of $50,000 above
 * when $60,000 they will pay 20% of first $50,000 = $10,000
 * + 50% of 10,000 = $5,000
 * AVR = $15,000/ $60,000 = 25%
 * MTR = 50%
 * 1 dollar = $0.50 to the gov.
 * determines the DWL of an income tax
 * how much tax system distorts incentives
 * Lump-Sum Tax **
 * Lump-sum tax has the same amount for every person
 * This tax shows the difference between average tax rate and marginal tax rate
 * MTR = 0
 * because no tax is owed on an additional dollar of income
 * Lump-sum tax is the most efficient tax possible
 * person's decision do not alter the amount owned
 * does not distort incentives
 * no SWL
 * minimal administrative burden
 * Why not use it?
 * most people would view it unfair because it takes the same amount from poor and riches

Taxes questions equity arised from disagreements over how the tax burden should be distributed. How should the burden of taxes be divided among the population? Benefits principle states that people should pay taxes based on the benefits they receive from government services. This principls tries to make public goods similar to private goods. Benefits principle also enforces the idea of the wealthy paying more because they benefit more from public services. Ability-to-pay principle states that taxes should be levied on a person according to houw weell tht person can shoulder the burden. This system is supported with an idea that everyone should make an "equal sacrifice." Ability-to-pay system also leads to two corollary notions of equity including:media type="youtube" key="OsGd6FWnY_0" height="344" width="425" align="right" Source: http://www.youtube.com/watch?v=OsGd6FWnY_0&feature=player_embedded ** Tax incidence and tax equity ** >    ** Who pays the corporate income tax? ** >    ** Trade-offs between equity and efficienct **
 * vertical equity
 * taxpayers with a greater ability to pay taxes should contribute a larger amount
 * Thus, richer pays more
 * But, how much?
 * Proportional tax
 * states the all taxpayers pay the same fraction of income
 * Regressive tax
 * states that high-income taxpayers pay a smaller fraction of their income
 * Progressive tax
 * states that high-income taxpayers pay a larger fraction of their income
 * horizontal equity
 * taxpayers with similar abilities to pay should contribute the same amount
 * Determine which differences are relevant for a family's ability to pay which differences are not
 * Marriage tax
 * treat as single taxpayer
 * increase in paying tax when married
 * increase in paying tax when married
 * Tax incidence
 * who bears into the burden of taxes
 * not always the person who gets the tax bill from the gov.
 * tax alter equilibrium point
 * affect people beyond those who actually pay taxes
 * many ignore the indirect effects of taxes
 * based on "flypayper theory" of tax incidence
 * burden of the tax sticks wherever it first lands
 * Corporation
 * ultimately burden falls on people
 * conflict
 * involves political philosophy & economy

Conclusion: In chapter 12, we learned about the desin of the tax system. Moreover, we now know how important the equity and efficiency works in tax system. However, some people say that changes in the tax laws increase efficiency, but not the equity.

Chapter Quiz 1. Compare and contrast the spending of federal government and state&local government. 2. What are the 2 objectives in taxing and how are those applied in laws? 3. What are the 4 main types of tax? Describe efficiency and equity of each tax.