Government RevenueGovernment Revenue

Citizens of the United States authorize the government, through the Constitution and elected officials, to raise money through taxes.

Taxation is the primary way that the government collects money.

Without revenue, or income from taxes, government would not be able to provide goods and services.

Taxes affect resource allocation and encourage/discourage certain activities

The Constitution and The Constitution and TaxationTaxation

The Power to Tax Article 1, Section 8,

Clause 1 of the Constitution grants Congress the power to tax.

The Sixteenth Amendment gives Congress the power to levy an income tax.

Limits on the Power to Tax The power to tax is also

limited through the Constitution. According to the Constitution:

1. The purpose of the tax must be for “the common defense and general welfare.”

2. Federal taxes must be the same in every state.

3. The government may not tax exports.

Tax StructuresTax StructuresProportional Taxes

– A proportional tax is a tax for which the percentage of income paid in taxes remains the same for all income levels. EX: “Flat Tax” proposal

Progressive Taxes– A progressive tax is a tax for which the

percent of income paid in taxes increases as income increases. EX: Federal Income Tax

Regressive Taxes– A regressive tax is a tax for which the

percentage of income paid in taxes decreases as income increases. EX: National Sales Tax proposal, Social Security Taxes

What Makes a Good Tax? What Makes a Good Tax? (As of there is such a (As of there is such a

thing)thing) Simplicity--Tax laws should be simple and

easily understood. (Look at a 1040—ha!)Certainty--It should be clear to the taxpayer

when the tax is due, how much is due, and how it should be paid. (Value-Added Tax bad for this)

Economy--Government administrators should be able to collect taxes without spending too much time or money.

Equity--The tax system should be fair, so that no one bears too much or too little of the tax burden. No loopholes.

To fully evaluate the fairness of a tax, it is important to think about who bears the incidence of a tax , or the final burden. If demand is inelastic, a tax will increase the price of a good and consumers will bear a large burden of the tax. If demand is elastic, the opposite is true.

Elasticities of Demand and Tax Effects

Quantity

Pri

ce

$1.40

$1.00

Lower quantity

Inelastic Demand

Higher quantity

New supply with $.50 tax

Original supply

f

i

Demand

Elastic Demand

Lower quantity

Higher quantity

QuantityP

ric

e

$1.10$1.00

New supply with $.50 tax

Original supply

ig

Demand

Section 1 ReviewSection 1 Review1. The power to tax is granted by the United States

Constitution to (a) the Treasury Department.(b) Congress.(c) the President.(d) the Supreme Court.

2. All of the following are characteristics of a good tax except(a) economy.(b) certainty.(c) revenue.(d) equity.

Individual Income TaxesIndividual Income Taxes

“Pay-as-You-Earn” Taxation– Federal income taxes are collected throughout

the course of the year as individuals earn income.

Tax Withholding– Withholding is the process by which employers

take tax payments out of an employee’s pay before he or she receives it.

Tax Brackets– The federal income tax is a progressive tax. In

2002, there are 6 rates, each of which applied to a different range of income. See handout.

A tax return is a form on which you declare your income to the government and determine your taxable income.

Taxable income is a person’s total (or gross) income minus exemptions and deductions.

HOURS AND EARNINGS

Hours Earnings

TAXES AND DEDUCTIONS

Description Amount

20 200.00 FICA

Federal

State

City

Total Taxes

15.20

10.25

5.10

1.00

31.55

TOTAL

Taxable Wages

200.00

Less Taxes

31.55

Net Pay

168.45

Exemptions are set amounts that you subtract from your gross income for yourself, your spouse, and any dependents.

Deductions are variable amounts that you can subtract from your gross income.

In the Beginning…In the Beginning…

Taxes originally were only applied against the extremely wealthy

The New Deal and World War II changed that, maybe forever

94% Tax rate during WW2 for the highest income earners

2 Principles of Taxation2 Principles of Taxation Benefit Principle Those who benefit the

most form taxes should pay in proportion to the benefits they receive

EX: Turnpike tolls Limitations: Benefits

hard to measure, and those who get the most can hardly pay for them.

EX: Large family gets huge benefits from public schools, low cost subsidized health care

Ability-to-Pay Principle People should be taxed

according to their ability to pay, regardless of benefits they receive

Argument: It’s the system that allows you to be wealthy.

Limitations: Fairness, destroys incentive, punishes people for doing well.

Top 25% of all income earners pay 83% of FIT

Individual Income TaxesIndividual Income Taxes

The government gets 48% of its revenue from the individual income tax (more than any other method)

Taxes are typically withheld, but individuals must file a tax return on or before April 15th of every year. 1099s must be send out by the end of January.

The tax is progressive in structure, but can be regressive in reality because of loopholes that allow wealthier citizens to deduct more expenses.

Some loopholes have been closed—Alternative Minimum Tax makes sure people with lots of tax-sheltered income still pay their fair share.

Adjusted Gross IncomeAdjusted Gross Income Tax Brackets: 2008 Tax Brackets: 2008

SINGLES: 10%:$0 to $8,025 15%:$8,026 to

$32,550 25%: $32,551 to

$78,850 28%: $78,851 to

$164,550 33%: $164,551 -

$357,700 35%: $357,701 +

MARRIED FILING JOINTLY: 10%: 0-$16,050 15%: $16,051-$65,100 25%: $65,101-131,450 28%: $131,451-$200,300 33%: $200,301-$357,700 35%: $357,701 +

Note “Marriage Penalty” Rates jump to 39.6% in

2011

Tax TerminologyTax Terminology W-2: Shows the amount of tax your employer

withheld W-4: Filled out when you are hired determines

withholding rate 1099: Shows interest income on investments.

Different types. Dividends (DIV), Retirement (R ), Tuition (G),

1040EZ: short form tax return, must have no dependents other than spouse, and must earn less than $50,000 with than $400 interest income

1040A: Can subtract IRA deductions, take child care credits, less than $50,000 income

1040: Main form 1040PC: Computer software tax form Form 4868/2688: Extensions (must pay interest)

Calculating Personal Income Calculating Personal Income TaxTax

Hypothetical Scenario: Male, age 29. Makes $60,000/year teaching little brats $100 interest income from bank CD No stock sales Deductions for home mortgage—must itemize ($4000) Has student loan interest to deduct, $2000 Charitable Contributions, $2000 Calculate this person’s tax and how much the Bush tax cut of

2001 saved him Would this teacher benefit from a Forbes-style “flat tax” of

17%?

How Much Tax Does the Poor Teacher How Much Tax Does the Poor Teacher Owe?Owe?

(Single Teacher)(Single Teacher) Take total tips and wages: $60,000 Interest income: 100 Total Income: $60,100 Subtract pers. exemption -3500 Student loan interest -2000 $5450 std deduction or ITEMIZE if more than $5450 Charitable Contributions -2000 Home mortgage interest -4000 State Income/Sales/Property tax deduction -4000 Total Itemized Deductions -10,000 AGI= $44600 Tax owed= (.10*8025)+ (.15*24525)+ (.25*12050)=

802.50+3678.75+3012.50= $7493.75 Ouch! Highest Marginal tax rate is 25 %. Would this

teacher be willing to teach college evening classes? Probably NOT. Extra income gets taxed at 25%, not 15%--Incentive is removed.

Overall tax rate: ($7493.75/$60100)=12.5% Note that charitable contributions, student loan interest

and mortgage interest are not 100% tax-deductible. Personal exemption can be higher if ITEMIZED--student

loan interest/mortgage is usually deductible on 1040A without itemizing. If you have large charitable contributions, ITEMIZE!

Tax brackets: Singles10%:$0 to $8,025 15%:$8,026 to $32,550 25%: $32,551 to $78,850 28%: $78,851 to $164,550 33%: $164,551 - $357,700 35%: $357,701 +

What about the 2001/03 Bush tax What about the 2001/03 Bush tax cuts?cuts?

Teacher w/o tax cut would have paid: (.15*32550)+ (.28*12050)=$8256.50

Teacher saves $762.75. Not bad. Dick Cheney saved $380,000 in 2002. BUT Dick Cheney also paid over $14 Million in tax at a

top marginal rate of 38.6% Flat tax result would depend on plan’s

exemption level.

Married Teacher Scenario—Married Teacher Scenario—or “Why I Love My L’il Tax Deduction”or “Why I Love My L’il Tax Deduction”

Take total tips and wages: $60,000 Interest income: 100 Total Income: $60,100 Subtract pers. exemptions - 7000 Student loan interest - 2000 No longer makes sense to itemize -10,900 std.

deduction AGI= $40,200 Tax owed= (.10*16050)+ (.15*24150)=$5227.50 Highest Marginal tax rate DROPS to 15 %. Married teacher with no spouse income saves

$2226.25 Overall tax rate: ($5227.50/$60100)=8.69% Mott CC here I come!

Tax brackets: Married Jointly10%: 0-$16,05015%: $16,051-$65,10025%: $65,101-131,45028%: $131,451-$200,30033%: $200,301-$357,70035%: $357,701 +

:

But we’re not done But we’re not done More taxes to pay!More taxes to pay!

Some of the poor single teacher’s money is taxed at 25%

Michigan State Income Tax= 4.35% flat rate in 2008 Social Security Tax= 7.65% until $70K (6.2% FICA

+1.45% Medicaid) City tax (in some localities, but not mine…Detroit is 2%) But then there’s sales tax, 6%, so if you spend some of

that $400, the tax rate shoots to 43% Add in property taxes—about $2000 a year..3% Do you smoke? Pay more tax. Total taxes can be more than HALF of your income As you can see, we are taxed to death in this society.

Incentives MatterIncentives Matter(Or why our tax code hurts (Or why our tax code hurts those who follow the rules)those who follow the rules)

Let’s suppose our single teacher had 4 kids and was a widower

Total Tax Owed? $60,100- (5450+ 3500*5)=$37150 AGI Tax= ($8025*.10)+(24525*.15)+ (.28*4600) =$5769.25 4 kids * $1000 child tax credit= $4000 Final tax bill= $1769.25 Tax saved by having 4 kids: $5724.50 Widowers could claim child care credits and pay even less. Father benefits more from services too—schools, etc. Obviously, this can be a sensitive topic and money is not

the only issue here—but it is nonetheless significant.

Corporation Income TaxCorporation Income Tax

Like an individual, a corporation must pay a federal tax on its taxable income.

Corporate income taxes are progressive – as a company’s profits increase so does the amount paid in taxes.

3rd largest source of government revenue Add in state corporate taxes and we have

some of the highest in the world—terrible for business and jobs here

2008 rates: 35% federal, w/state tax average is 39.3%

What the heck is this FICA?What the heck is this FICA?(2(2ndnd largest source of Gov’t revenue) largest source of Gov’t revenue)

Social Security Taxes-This program is funded by the Federal Insurance Contributions Act (FICA). Most of the FICA taxes you pay go to Social Security, or Old-Age, Survivors, and Disability Insurance (OASDI)

Medicare Taxes-Medicare is a national health insurance program that helps pay for health care for people over 65 and for people with certain disabilities. Medicare is also funded by FICA taxes.

Unemployment Taxes-Unemployment taxes are collected by both federal and state governments. Workers can collect “unemployment compensation” if they are laid off through no fault of their own and if they are actively looking for work.

Side note: Totalization agreements with the SSA exist

Other TaxesOther Taxes Excise Taxes-- a tax on the sale or production of a good.

Federal excise taxes range from gasoline to telephone services. Alcohol and cigarettes are subject to excise taxes, frequently called “sin taxes.” You can also include “gas guzzler” tax on a Viper and Luxury tax on yachts, etc (Thank goodness that one’s gone. Why?)

Estate Taxes--a tax on the estate, or total value of the money and property, of a person who has died. Estate taxes are paid before inheritors receive their share.

Gift Taxes--tax on the money/property that a person gives to another. $10,000/person per year is exempted

Tariffs--Taxes on imported goods. Usually protective. EX: Bush slapped 30% tax on imported steel to help American steelworkers. Result? Prices go up 30%.

Customs Duties—levy on goods from another country Capital Gains--Investments taxed at different rate from

income. Even home sales count as capital gains.

Recent Tax HistoryRecent Tax History

Economic Recovery Act of 1981 reduced taxes, 1986 act cut top rate to 28%.

President Bush (41) went along with a Democrat-controlled Congress and raised taxes to 31%.

Omnibus Budget Reconciliation Act of 1993 added 2 higher tax brackets, 36% and 39.6%

1997: Taxpayer Relief Act passed by Congressional Republicans. Additional tax credits for children and educational expenses and reduced long term capital gains taxes (25%20%). No income rate reductions.

2001--Top rate cut to 35%; 2003- Tax on dividends and capital gains slashed to

15% (5% if you’re in the lower two brackets)

The Supply-Side Theory of The Supply-Side Theory of TaxationTaxation

Supply-Side Economics (a.k.a. “Trickle down theory”) If you cut taxes on the wealthy, they will spend and

invest their additional discretionary income. This spending picks up business, and businesses

must hire new workers. Now that these new workers have a paycheck, they

spend and their purchases put businesses in a position to higher even more workers.The cycle continues indefinitely.

Revenues actually increase; people are wealthier and pay more taxes, even though the % taxed is LESS!!!

Proof: Revenues doubled in 1980s after 2 Reagan cuts

Key believers: Andrew Mellon, Ronald Reagan Why does this make sense? Laffer Curve (see next

slide)

The Laffer CurveThe Laffer Curve

Proposals for ReformProposals for Reform

Value-Added Tax: Places a tax on manufactured goods at each level of production. Simple, but potentially misleading to consumers. Used extensively in Europe.

Flat Tax: Exceedingly simple, would save time and money in collecting. It is progressive as long as there is some level of exempted income. Seen as a giveaway to the very rich, but consider trickle-down.

National Sales Tax (Consumption tax)

Taxation Section ReviewTaxation Section Review1. Taking taxes out of an employee’s wages before he or she

receives them is called(a) tax return.(b) social security.(c) FICA.(d) withholding

2. How is the federal income tax a progressive tax?(a) The higher the income a person has, the higher the

percentage that person pays as tax.(b) A person with a higher income pays more money in

taxes, although the percentage he or she pays as tax is less.

(c) Two married people who file their taxes together will pay more taxes than a single person will.

(d) Children pay no taxes, regardless of whether they earn a large income

State BudgetsState BudgetsOperating Budgets

– A state’s operating budget pays for day-to-day expenses. These include salaries, supplies, and maintenance of state facilities.

Capital Budgets– A state’s capital budget pays for major

capital, or investment, spending. Balanced budgets

– Some states have laws requiring balanced budgets. These laws, however, only apply to a state’s operating budget.

Budgets mean TAXATION IS PRESENT!

State Government Revenue State Government Revenue SourcesSources

Intergovernmental revenues are funds collected by one level of government and distributed to another. They make up ¼ of all state revenues and are the largest source.

Most states have sales taxes—2nd largest source. Employee retirement contributions are the 3rd largest source

of income Individual income taxes—4th largest (depends on state) Other sources: Interest on surpluses, fees from state-owned

colleges, corporate income taxes, fees from licensing Public lotteries are another source of funding (In Michigan, all

lottery money goes to public education)

State and Local TaxationState and Local TaxationLimits to State Taxation

– Because trade and commerce are considered national enterprises, states cannot tax imports or exports. They also cannot tax goods sent between states.

Sales Taxes

– Sales taxes are the main source of revenue for many states

Other State Taxes

– Different states have various other means to collect revenue, such as state income taxes, excise taxes, corporate income taxes, business taxes, and property taxes.

Local Government Local Government RevenueRevenue

Property taxes are the main source of local revenue. These taxes are paid by people who own homes, apartments, buildings, or land.

Michigan: Proposal A (1994) eliminated the funding of schools with property taxes

Local governments sometimes collect excise, sales, and income taxes.

Some taxes, such as room and occupancy taxes, are aimed at nonresidents in order for local governments to earn additional revenue.

What do these Monstrous What do these Monstrous Taxes Pay For?Taxes Pay For?

National defenseWelfare programsPublic education (Federal

prerogative?)Interest on the national debtPork barrel spending

Ok, but where do state taxes Ok, but where do state taxes go?go?

Education--State education budgets help finance public state universities and provide some aid to local governments for elementary, middle, and high schools.

Public Safety--State governments operate state police systems, as well as correctional facilities within a state.

Highways and Transportation--Building and maintaining highways is another state expense. States also pay some of the costs of waterways and airports.

Public Welfare--State funds support some public hospitals and clinics. States also help pay for and administer federal benefits programs.

Arts and Recreation--State parks and some museums and historical sites are funded by state revenues.

Administration--Like the federal government, state governments spend money just to keep running.

The Jobs of Local The Jobs of Local GovernmentGovernment

Public school systemsLaw enforcementFire protection

Public transportationPublic facilities, such as libraries and

hospitalsParks and recreational facilities

Record keeping (birth/death certificates, wills, etc.)

Section ReviewSection Review

1. For most state governments, the main source of revenue is a (a) room tax.(b) property tax.(c) general excise tax.(d) statewide sales tax.

2. The main source of revenue for local governments is (a) a property tax.(b) an excise tax.(c) a sales tax.(d) an income tax.