Chapter Nine – Sources of Government Revenue

Section One – The Economics of TaxationI. Economic Impact of Taxes

i. Total tax revenue even when adjusted for inflation has risen dramaticallya. Resource Allocation

i. Affects factors of production (makes the supply curve move left)ii. When prices rise some consumers choose to buy other goods, fundamentally altering some industries

b. Behavior Adjustmenti. Used to encourage or discourage some behavior

- deduct mortgage interest- sin taxes (liquor, tobacco)

c. Productivity and Growthi. Could discourage productivity (higher income taxes)ii. At what level do productivity and growth suffer?

d. The Incidence of a Taxi. The final burden of a tax

- higher prices- lower wages

II. Criteria of Effective Taxesa. Equity

i. People want them to be fair- Flat Tax or Progressive Tax?

b. Simplicityi. Sales tax is much simpler than the Income Tax

c. Efficiencyi. Easy to administer ii. Raise enough revenue to be worthwhile

III. Two Principles of Taxationa. Benefit Principle

i. Those who benefit from the governments goods and services should pay in proportion to the amount of benefits they receive (gas tax built into the price)ii. Benefits often difficult to measureiii. Those who receive the benefits are often the least able to pay

b. Ability-to-Pay-Principlei. Higher taxes for people with higher incomes (Progressive Taxes)ii. The assumption is the wealthy will suffer less by paying higher taxes

IV. Types of Taxesi. Proportional Tax – Same percentage rate on everyoneii. Progressive Tax – Higher percentage rate of taxation on people with higher incomesiii. Regressive Tax – Higher percentage rate of taxation on lower incomes

- Often times based on consumption

Section Two – The Federal Tax SystemI. Individual Income Taxes

a. Payroll Deductionsi. Employers automatically deduct income taxes from your paycheckii. Tax returns are due April 15th

b. A Progressive Income Taxi. Average tax rate goes up as your income goes up

c. Indexingi. An upward revision of tax brackets to keep workers from paying more taxes just because of inflation

II. FICA Taxesa. Social Security Taxes

i. Capped at a fixed income level then regressive afterwardsii. It’s proportional until the cap

b. Medicarei. Set at a flat rate and not capped

III. Corporate Income Taxesi. Taxes corporations pay on their profits

IV. Other Federal Taxesa. Excise Taxes

i. Tax on the manufacture or sale of an item (gasoline, liquor)ii. Tend to be regressive

a. Estate and Gift Taxesi. Estate Tax - tax the government levies on the transfer of a property when someone diesii. Gift Tax – tax on the donations of money or wealth and is paid by the person who makes the gift

b. Customs Dutiesi. Charge levied on goods brought in from other countriesii. Congress decides what to tax and at what rate

c. Miscellaneous Feesi. User Fees – Based on the benefit principle

- more favorable than taxes

Section Three – State and Local TaxesI. State Government Revenue Sources

a. Intergovernmental Revenue Sourcesi. Funds government receives from another level of government

- federal transfers to the states- over 20% of all state revenues

b. Taxes and Feesi. Sales taxes are the 2nd largest source of revenue for states

- about 20%ii. Other taxes or fees cover retirement funds and pension plans

- 3rd largest source of revenueiii. Individual income taxes are the 4th largest source of state revenue

c. Other Revenuesi. Earnings on surplus fundsii. Tuition and other fees collected by state funded institutions

d. The Choice of Taxi. Many states run lotteries to collect fundsii. Money must be collected in one form or another

II. Local Government Revenue Sourcesa. Intergovernmental Revenues

i. 1/3rd of their revenues from state governments- usually intended for education or welfare

b. Property Taxesi. 2nd largest source of revenueii. Determined on land value

c. Other Sourcesi. Earnings on public utilitiesii. Some cities have a separate sales tax

III. Examining Your Paychecki. These funds are deducted from your paycheck

Section Four – Current Tax IssuesI. Tax ReformII. The Value Added Tax

a. Concept of Value Addedi. tax each stage of value added to a product

- logger-mills-manufacturer-wholesaler-retailerb. Advantages of a VAT

i. the tax is spread making it harder to shift the burdenii. Its hard to avoid and easy to collectiii. Some argue it encourages savings

c. Disadvantages of a VATi. tends to be invisible to consumersii. It would compete with state sales taxes

III. The Flat Taxa. Advantages of a Flat Tax

i. It’s simpleii. It closes tax loopholesiii. Reduces the need for tax accountants, preparers and some of the IRS

b. Disadvantages of a Flat Taxi. eliminates some of the incentives already built into the tax code

- mortgage deductions, charitable donationsii. May benefit people with high incomes rather than the middle class

IV. The Inevitability of Future Reformsi. the income tax is very complex