Preview Activity Grab one piece of poster paper
Preview Activity • Grab one piece of poster paper group along with a couple markers. Complete the following tasks on poster paper: 1. List as many public goods and services as possible. Categorize them according to federal, state, and local levels of government (which level provides each public g/s? ). 2. List as many “alphabet” government agencies as you can (for example, the FBI). 3. Why does the government play so many roles? Frame your response in the context of what you’ve been learning the past few days. Copyright © 2004 South-Western/Thomson Learning
The Design of the Tax System Copyright© 2004 South-Western 12
“In this world nothing is certain but death and taxes. ”. . . Benjamin Franklin 100 80 60 40 20 0 1789 Taxes paid in Ben Franklin’s time accounted for 5 percent of the average American’s income. Copyright © 2004 South-Western/Thomson Learning
“In this world nothing is certain but death and taxes. ”. . . Benjamin Franklin 100 80 Today, taxes account for up to a third of the average American’s income. 60 40 20 0 1789 Today Copyright © 2004 South-Western/Thomson Learning
Figure 1 Government Revenue as a Percentage of GDP Revenue as Percent of 35 GDP Total government 30 25 State and local 20 15 Federal 10 5 0 1902 1913 1922 1927 1932 1940 1950 1960 1970 1980 1990 Copyright © 2004 South-Western 2000
Table 1 Central Government Tax Revenue as a Percent of GDP Copyright© 2004 South-Western
The Federal Government • Collects 2/3 of the taxes in our economy • Largest source of gov’t rev. = ind’l income tax • Tax rate rises as taxable income rises Copyright © 2004 South-Western/Thomson Learning
Table 2 Receipts of the Federal Government: 2001 Copyright© 2004 South-Western
The Federal Government • Gov’t spending includes: • Transfer payments (largest category!) • i. e. social security • Purchase of public goods and services Copyright © 2004 South-Western/Thomson Learning
The Federal Government • 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. Video Clips Copyright © 2004 South-Western/Thomson Learning
TAXES AND EFFICIENCY • Policymakers have two objectives in designing a tax system. . . • • Efficiency Equity • The Cost of Taxes to Taxpayers • The tax payment itself • Deadweight losses • Administrative burdens Copyright © 2004 South-Western/Thomson Learning
Happy Thursday • Take out your class notes, please and thank you. Copyright © 2004 South-Western/Thomson Learning
TAXES AND EFFICIENCY • One tax system is more efficient than another if it raises the same amount of revenue at a smaller cost to taxpayers; deadweight losses and administrative burdens are minimized. • An equitable tax system is one where the burden of taxes is distributed fairly. Copyright © 2004 South-Western/Thomson Learning
Marginal Tax Rates vs. Average Tax Rates • ATR = total taxes paid divided by total income • Helps to measure the sacrifice made by a taxpayer by showing the fraction of income paid in taxes • MTR = extra taxes paid on an additional dollar of income • Helps to measure how much the tax system distorts incentives, and therefore, deadweight loss. • Example: Suppose the government taxes 20% of the first $50, 000 of income and 50% of all income above $50, 000. • How much would an individual making $60, 000 pay in taxes? • What is the ATR for this individual? • What is the MTR for this individual? Copyright © 2004 South-Western/Thomson Learning
Copyright © 2004 South-Western/Thomson Learning
Lump-Sum Taxes • 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. • Example: Suppose the government imposes a tax of $4, 000 on everyone. • How much would an individual with an income of $20, 000 pay in taxes? What is the ATR for this individual? What is the MTR for this individual? • How much would an individual with an income of $40, 000 pay in taxes? What is the ATR for this individual? What is the MTR for this individual? • What do you notice? Why do you think we don’t usually observe lumpsum taxes in the real world? Frame your answer in the context of efficiency and equity. Copyright © 2004 South-Western/Thomson Learning
TAXES AND EQUITY • How should the burden of taxes be divided among the population? • How do we evaluate whether a tax system is fair? Copyright © 2004 South-Western/Thomson Learning
Taxes & Equity • Benefits Principle: People should pay taxes based on the benefits they receive from gov’t 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. $ • Think of another example… Copyright © 2004 South-Western/Thomson Learning
Taxes & Equity • Ability-to-pay principle: Taxes should be levied on a person according to how well that person can shoulder the burden; all citizens should make an “equal sacrifice”. • Think: A $1, 000 tax paid by a poor person may require larger sacrifice than $10, 000 paid by a rich person. • Vertical equity: taxpayers with greater ability to pay should contribute larger amount. • Horizontal equity: Taxpayers with similar abilities to pay should contribute the same amount. Copyright © 2004 South-Western/Thomson Learning
Ability-to-Pay Principle • Vertical Equity and Alternative Tax Systems: In all three scenarios, taxpayers with higher incomes pay more. However, how much taxes rise with income differs. • A proportional tax is one for which high-income and lowincome taxpayers pay the same fraction of income. • A regressive tax is one for which high-income taxpayers pay a smaller fraction of their income than do low-income taxpayers. • A progressive tax is one for which high-income taxpayers pay a larger fraction of their income than do low-income taxpayers. Copyright © 2004 South-Western/Thomson Learning
Table 7 Three Tax Systems procon. org Copyright© 2004 South-Western
How is the U. S. tax system structured? Copyright © 2004 South-Western/Thomson Learning
Tax Incidence and Tax Equity • 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. • Much of the debate over tax policy arises because people give different weights to the two goals of efficiency and equity. Copyright © 2004 South-Western/Thomson Learning
Tax Alternatives Activity Scenario: The state has decided to increase funding for public education. They are considering four alternative taxes to finance these expenditures. Assume all four taxes would raise the same amount of revenue. • • A sales tax on food A tax on families with school-age children Property tax on vacation homes Sales tax on jewelry 1. Analyze and evaluate these taxes using the benefits principle. 2. Analyze and evaluate these taxes using the principle of horizontal equity. 3. Classify each tax as progressive, proportional, or regressive. 4. Which tax would you choose to finance education? Explain. Copyright © 2004 South-Western/Thomson Learning
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