Pub Econ Lecture 18 Taxation

8/3/2019 Pub Econ Lecture 18 Taxation

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Public Finance

Dr. Katie Sauer

Taxation



Figure 18-1



Figure 18-2



Calculating your Federal Income Tax

1. compute gross income

- wages, salaries

- interest, dividends, rental income



2. compute adjusted gross income

subtract off:- retirement savings contributions

- alimony

- educator expenses

- contributions to HSAs- job-related moves expenses

- interest paid on student loans

- if self-employed:- health insurance premiums

- 50% of paid payroll taxes





Exemptions used to be ³phased out´ for very high

income levels.

- personal exemption phaseout (PEP)

These limits will not apply for the year 2010, 2011 or

2012.

The limits will come back in 2013 (unless further legislation is passed).



Income Range for PEP (2009)

Filing Status Phaseout Begins Phaseout Ends

Married Filing Jointly 250,200 372,700

Qualifying Widow(er) 250,200 372,700Head of Household 208,500 331,000

Single 166,800 289,300

Married Filing Separately 125,100 186,350



4. Decide on deduction type

Standard Deduction:

$11,600 for married couples filing jointly

$5,800 for singles

$5,800 for married individuals filing separately$8,500 for heads of household

additional standard deduction for blind people

and senior citizens$1,150 for married individuals

$1,450 for singles and heads of household



Itemized Deduction:

- medical and dental expenses exceeding 7.5%of AGI

- other taxes paid (state, local income tax)

- interest on mortgage

- charitable donations

- casualty and theft losses

- union dues and job travel expenses



According to the IRS, 2 out of 3 tax payers takes the

standard deduction .

(IR-2010-127, Dec. 23, 2010)



5. Compute Federal Income Tax Owed

Here are the tax brackets for a single person for 2011:

Marginal Tax Tax Bracket

Rate over but not over

10% $0 $8,500

15% $8,500 $34,500

25% $34,500 $83,600

28% $83,600 $174,400

33% $174,400 $379,150

35% $379,150



Suppose you are single in 2011 and your AGI is $50,000.

Marginal Tax Tax BracketRate over but not over

10% $0 $8,500

15% $8,500 $34,500

25% $34,500 $83,600

38% $83,600 $174,40033% $174,400 $379,150

35% $379,150

On the first $8500, you pay 10% in taxes.8500 x 0.10 = 850




10% $0 $8,500

15% $8,500 $34,500

25% $34,500 $83,600

38% $83,600 $174,40033% $174,400 $379,150

35% $379,150

On the next portion of income, you pay 15% in taxes.34500 ± 8500 = 26000

26000 x 0.15 = 3900




10% $0 $8,500

15% $8,500 $34,500

25% $34,500 $83,600

38% $83,600 $174,40033% $174,400 $379,150

35% $379,150

On the next portion of income, you pay 25% in taxes.50000 ± 34500 = 15500

15500 x 0.25 = 3875



The total amount you pay in taxes is:

= (0.10)(8500) + (0.15)(34500-8500) + (0.25)(50000-34500)

= 850 + 3900 + 3875

= 8625



The marginal tax rate is the extra taxes paid on anadditional dollar of income.

If your AGI is $50,000 and then you earn one extradollar of income, that dollar is taxed at a rate of 25%.

Your current marginal tax rate is 25%.



The average tax rate is the total taxes paid, divided by

total income.

= 8625 / gross income

Suppose your gross income is $60,000.

= 8625 / 60000= 14.4% is your average tax rate



How your Federal taxes are spent http://www.whitehouse.g ov/taxreceipt



Colorado has a flat 4.63% income tax

http://www.col orad o.g ov/taxtrack s/



The Haig-Simons Comprehensive

Income Definition

It defines taxable re source s as an individual¶s ability t o

pay taxes.

The ability t o pay is equal to an individual¶s potential

annual con sumption.

P o

tential annu

al co

n su

mption is equal to t

otal con sumption during the year pl us any increa se in wealt h.



This is how public economists define income.- improves vertical efficiency (high income pay

a larger share of income in taxes)

- those who have more resources pay

more in tax

- improves horizontal efficiency (same incomes

pay same taxes)

- same underlying resources pay same intax



Difficult to do in practice:

On ability-to-pay grounds, we might like to deduct- property and casualty losses

- medical expenditures

- state and local tax payments



On externality/public goods grounds we might deviate

for - charitable giving

- housing



Charitable Giving

Suppose there are not enough homeless shelters.

- government could finance

- government could give incentives to private

sector to provide

When charitable donations are tax deductible, charitable

giving is ³cheaper´ relative to other types of

consumption.

It might be preferred to have tax subsidy crowd-in as

opposed to government spending crowd-out.



Ex: Ellie is deciding whether to buy a $1 cup of coffee

or to donate $1 to a homeless shelter.

To get $1 to spend on coffee, she¶ll have to earn more

than $1:

$1 / (1 ± tax rate)

To get $1 to spend on a donation, she¶ll have to earn

exactly $1:

$1 / (1 ± 0)



The relative price of charitable giving is:

= $1

$1 / (1 ± tax rate)

= $(1 ± tax rate)



This type of preferred tax treatment yields a benefit at thecost of deviating from Haig-Simons.



To consider:

When the government gives a tax subsidy for an action,

it will be giving a tax break to individuals who would

have taken t he action anyway.

- inframarginal impact

When the government gives a tax subsidy for an action,

some people are incentivized to take the action.

- marginal impact



The government should use a tax break instead of direct

spending if:

the increase in charity > 1 ± the reduction in

per dollar of tax break charity per dollar of

government spending



Tax subsidies may also be preferred to government

spending on consumer sovereignty grounds.

- when government spends, it is imposing its preferences

- when individuals spend, they express their own

preferences



Housing

If the mortgage deduction were discontinued, it isestimated federal tax revenues would rise by $80

billion per year.

Why subsidize home ownership?

- in theory has positive externalities that renting

does not

- stake in society, neighborhood, town

- vote for long run investments

- mixed empirical evidence



Effect of housing tax subsidies:

- doesn¶t seem to induce people to buy homes

- does increase expenditures on housing

- for every $1 more of tax subsidies, $1

more is spent on housing

« no real justification to deviate from Haig-Simons

« very popular



If we are going to deviate from Haig-Simons,

is it better to use tax deductions or tax credits?

T ax ded uction s allow taxpayers to reduce their taxableincome.

T ax credit s allow taxpayers to reduce the amount of the

tax that they owe.



Efficiency Considerations: unclear

Consider replacing the current deductibility of charitable donations with a 100% tax credit, up to

$1000.

If you gave less than $1000:- likely give full $1000 now because your

tax bill goes down by $1 for every $1 you

give

If you gave more than $1000:

- less of an incentive to give once reach

$1000



Two considerations for efficiency:

1. nature of demand for the subsidized good

- elastic « credits may induce more giving

2. importance of achieving a minimum level of

the behavior

- credit can induce a minimum level



Equity Considerations:

Vertical

- tax credits are more equitable than deductions- deductions are regressive

- credits are progressive



Another consideration: are tax credits refundable?

Refundable means available to individuals who owe fewor no taxes.

- increase refund amount



Tax Expenditures

The existing set of deviations from Haig-Simons is aset of tax expendit ure s.

- government revenue losses attributable to tax

law provisions that allow special exclusions,exemptions, or deductions from gross income

- government revenue losses attributable to tax

law provisions that provide a special credit, preferential tax rate, or deferral of liability



Table 18-2

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Pub Econ Lecture 18 Taxation

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