Principles of Microeconomics : Ch.12 Second Canadian Edition Chapter 12 The Design of the Tax System...

Principles of Microeconomics : Ch.12 Second Canadian Edition

Chapter 12

The Design of the Tax System

© 2002 by Nelson, a division of Thomson Canada Limited


Overview

Financial Overview of the Canadian Government

Taxes and EfficiencyTaxes and EquityConclusion


“In this world nothing is certain but death and taxes.” (Benjamin Franklin)

In 1961, taxes accounted for about 28 % of total income!

19610

20

40

60

80

100

1961

Percent of total income


“In this world nothing is certain but death and taxes.” (Benjamin Franklin)

Today, taxes account for

about 40 % of total income!

1961

To

day0

20

40

60

80

100

1961

To

day

Percent of total income


The Tax System

When the government addresses the problem of externalities, provides public goods, or regulates the use of common resources, it can raise economic well-being.

For the government to perform these and its many other functions, it needs to raise revenue.


The Tax SystemMost people agree

that taxes should impose as small a cost on society as possible, i.e...

… the tax system should be

efficient and equitable.


A Financial Overview of the Canadian Government

Where does the government get its income from?

What does the government spend its income on?


The Canadian Federal StructureThere are three levels of government -

federal, provincial, local.The B.N.A. Act sets out the responsibilities

of the federal and provincial governments.The local governments derive authority

from the provincial governments.The Federal government has unlimited

taxing powers.


The Federal Government: Revenue

The major sources of tax revenue of the federal government include:

– Personal Income Taxes

– Corporate Income Taxes

– Goods and Services Taxes

– Payroll Taxes

– Other


The Federal Government: Revenue

Personal Tax

Corporate Tax

GST

Payroll Tax

Excise Tax

Other


Personal Income Taxes... The largest source of government revenue

Tax Liability is how much tax an individual owes and is based upon total income.

Marginal Tax Rate is the tax rate applied to each additional dollar of income. Higher-income individuals pay a larger percentage of their income in taxes.


Federal Government Spending

About 30% of total government spending is on servicing the public debt.

The remaining 70% of government spending is called “Program Spending.”


Federal Government Spending

Debt Service

Elderly Benefits

CHST

Subsidies & Transfers

EI

Defense

Other


Financial Conditions of the Federal Budget

Budget Deficit– Situation where the expenses of the

budget are greater than the revenues.

– Government finances the deficit by borrowing from the public.

Budget Surplus– Situation where the revenues are greater

than the expenses. Used to pay outstanding debts.


The Provincial Government: Revenue

Personal Tax

Transfers

Sales Tax

Excise Tax

Corporate Tax

Payroll Tax

Health Levies

Other


The Provincial Government: Spending

Health

Education

Social Services

Debt Services

Other


Local Governments: Municipalities and School Boards

Spending– Education

– Protection of People and Property

– Other

Receipts– Property Taxes– Transfers– Other


Quick Quiz!What are the two most

important sources of tax revenue for the federal government?

What are the three most important expenditures for provincial governments?


Overview




Taxes and Efficiency

The aim of a tax system is to raise revenue for the government. Two objectives of designing a tax system:

Efficiency

EquityA tax system is more efficient if it can

raise the same amount of revenue at a smaller cost to the taxpayers.


Related Costs of Taxes to Taxpayers

The costs of taxes to taxpayers:– The tax payment itself

Transfer of money from taxpayer to government.

– Deadweight losses

– Administrative burdensAgain, an efficient tax system is one

which minimizes these costs.


Deadweight Loss of TaxationWhen a tax is levied on buyers, the

demand curve shifts downward by the size of the tax...

When a tax is levied on sellers, the supply curve shifts upward by that amount... The losses to buyers and sellers exceed the tax revenue, leading to a

Deadweight Loss.


Administrative & Compliance CostsAdministrative Costs include:

– Collection and enforcement expenses.Compliance costs include:

– The time spent in early spring filling out forms.

– Payment for tax experts in assisting the taxpayer in filing tax returns.

The cost to the taxpayer is greater than the actual tax payment made.


The Goal of an Efficient Tax SystemAn efficient tax system is one that

imposes small deadweight losses and small administrative and compliance burdens.

Suggested strategies to enhance efficiency include:– simplifying the tax system

– broader based taxes


Alternative Tax RatesEfficiency and equity of income taxes

leads to three notions of tax rates:Average Tax Rate...

...is total taxes paid divided by total incomeMarginal Tax Rate...

...is the extra taxes paid on an additional dollar of income

Lump-Sum Tax Rate......everyone owes the same amount of tax


Quick Quiz!

What is meant by the efficiency of a tax system?

What can make a tax system inefficient?


Overview




Taxes and Equity

How should the burden of taxes be divided among the population?

How do we evaluate whether a tax system is fair?

Benefits Principle

Ability-to-pay Principle


Taxes and Equity: Benefits Principle

“People should pay taxes based on the benefits they receive from government

services.”Example:

– Gasoline Tax: These tax revenues are used to finance our highway system.

– People who drive the most, use the road the most, also pay the most toward their upkeep.


Taxes and Equity: Ability-to-pay Principle

“Taxes should be assigned based on an individual’s ability to shoulder the tax

burden.”Two notions of equity:

Vertical EquityHorizontal Equity


Vertical Equity“Differently situated individuals should

be treated differently.”Example: People with higher incomes

should pay more than people with lower incomes. – Alternative Tax Systems:

ProportionalRegressiveProgressive


Horizontal Equity

“Would require people of like incomes to pay the same amount of tax.”

Example: Two different families with the same number of dependents and the same income living in different parts of the country should pay the same federal taxes.


Taxes and Equity

The difficult part of tax policy is to balance the sometimes conflicting nature of the efficiency and equity goals.

The study of who bears the burden of taxes is central to evaluating tax equity. This is called Tax Incidence.


Quick Quiz!

Explain the benefits principle and the ability-to-pay principle.

What are vertical equity and horizontal equity?

Why is studying tax incidence important in determining equity in a tax system?


Overview




Conclusion: The tradeoff between equity and efficiency

Equity and efficiency are the two most important goals of the tax system. But often these goals conflict.

Many proposed changes in the tax laws increase efficiency while reducing equity, or increase equity while reducing efficiency.


Overview



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Principles of Microeconomics : Ch.12 Second Canadian Edition Chapter 12 The Design of the Tax System...

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