The design of the tax system

Chapter 12

A financial overview of the U.S government

•Amazingly, the U.S federal government collects 2/3 of the taxes in the economy

•The largest source of revenue for the federal government is the individual income tax.

Individual income taxes

•Higher- income families pay a larger percentage than other families from their income.

•Marginal tax rate is the tax that applies to the last dollar of the tax base (taxable income or spending), and often applied to the change in one’s tax obligation as income rises.

What kind of taxes are there?

•Payroll tax: paid from the firm’s own funds and which are related to employing a worker

•Social Insurance tax: taxes on wages that designates to pay social security.

•Excise tax: a type of tax charged on goods produced within the country e.g) Gasoline.

Government Spending goes

where? •Health

•Medicare

•National Defense

•Social Security

•Income Security

Government Spending

Social Security,23%

Defense, 16%

Net Interest, 13%

Income security, 14%

Medicare, 12%

Health, 8%

Other, 14%,

Federal Government

•Budget deficit: A budget deficit occurs when the government plans to spend more money than it takes in.

•Budget surplus: The opposite of Budget deficit.

Deadweight Loss??

•Taxes distorts incentives, therefore, a deadweight loss is made.

•Distortions occur because people or firms change their behavior in order to reduce the amount of tax they must pay.

Booyah

Administrative Burden

•Many taxpayers usually hire tax lawyers to help them with their taxes.

•However, by complying with tax laws, it creates more deadweight loss.

•Therefore, the administrative burden involved in any tax system is inefficient.

Efficiency? Equity??

•Yes as a matter of fact there are taxes that helps equity.

•And there are also a few taxes that hlep efficiency

Efficiency

•Usually an Efficiency tax system has a smaller deadweight loss and administrative burden.

•It is efficient when the tax system raises the same amount of revenue at a smaller cost to the taxpayers.

Types of Taxes

•Average tax rate, Marginal tax rate

•ATR, tax rate on an income tax, divide total tax liability by taxable income

•MTR, tax rate that applies to the last dollar of the tax base

Types of Taxes

•Lump sum Taxes- A tax where the tax is the same for every person.

Benefit Principal

•Benefit Principal- a taxation principle stating that those who benefit more from a product or service should pay more taxes on the product or service than those who benefit less

Ability to pay principal

•Tax should be levied depending on how well a person could handle a burden.

•The ability to pay principal leads to to notions of equity: vertical and horizontal equity.

The ability to pay principal

•Vertical Equity- collecting income tax in which the taxes paid increase with the amount of earned income (boo for rich people).

•Horizontal Equity- people in the same income stage should be taxed at the same rate.

More taxes•Proportional tax- An income tax that

takes the same percentage of income from everyone regardless of how much an individual earns.

•Regressive tax- A tax that takes a larger percentage from low-income people than from high-income people.

•Progressive tax-A tax that takes a larger percentage from the income of high-income people than it does from low-income people.

Tax Incidence

•It is difficult to balance Efficiency and Equity

•The tax incidence is the analysis of the effect of a particular tax on the distribution of economic welfare.

Summary

•Payroll and individual income taxes are important for federal government

•Efficiency and Equity is the main goal of the tax system.

•The administrative burden creates DWL because it complies with the tax laws.

Summary

•Equity concerns whether everybody pays fairly among the population

•Efficiency refers to the costs it forces on taxpayers.

Questions

•1. Why is deadweight loss created when there is taxation?

•2. If you wanted the tax to be Equity, which tax would you use?

•3. What happens if the Administrative burden rises?

Answers

•1. Taxes distorts incentives, therefore, a deadweight loss is made.

•2. Lump-sum tax

•3. The dead weight loss will increase because the administrative burden involved in any tax system is inefficient.