Taxes (3/3/16) I. Basics about taxes A.2 principles of tax fairness 1.Benefits principle: those who benefit should pay a.Examples: b.Any problems with this? 2.Ability to pay principle: those who are able to pay more should a.Examples: b.Any problems with this?

Assess the following four tax policies in terms of the benefit principle versus the ability to pay principle. a. A tax on semi-truck tires that finances maintenance of state roads b. An 8% tax on imported goods valued in excess of $800 per household brought in on passenger flights c. Airline-flight landing fees that pay for air traffic control d. A reduction in the amount of income tax paid based on the number of dependent children in the household

B. Equity vs. efficiency 1. A lump-sum tax where everyone pays the same amount (ex: everyone pays $500) vs. tax based on property values (ex: everyone pays 1% of their home’s value) a. Which tax is more efficient? (hint: which tax is more likely to distort people’s behavior? Behavior distortion  inefficiency) Which tax is more equitable?

C. Income tax = progressive tax Taxable income = income after your deductions Single Filing Status – Federal Income Tax - Year % on taxable income from $0 to $9,225, plus 15% on taxable income over $9,225 to $37,450, plus 25% on taxable income over $37,450 to $90,750, plus 28% on taxable income over $90,750 to $189,300, plus 33% on taxable income over $189,300 to $411,500, plus 35% on taxable income over $411,500 to $464,800, plus 39.6% on taxable income over $464,800.

Single Filing Status – Federal Income Tax - Year % on taxable income from $0 to $9,075, plus 15% on taxable income over $9,075 to $36,900, plus 25% on taxable income over $36,900 to $89,350, plus 28% on taxable income over $89,350 to $186,350, plus 33% on taxable income over $186,350 to $405,100, plus 35% on taxable income over $405,100 to $406,750, plus 39.6% on taxable income over $406,750. Single Filing Status – Federal Income Tax - Year % on taxable income from $0 to $9,225, plus 15% on taxable income over $9,225 to $37,450, plus 25% on taxable income over $37,450 to $90,750, plus 28% on taxable income over $90,750 to $189,300, plus 33% on taxable income over $189,300 to $411,500, plus 35% on taxable income over $411,500 to $413,200, plus 39.6% on taxable income over $413,200.

Single Filing Status – Federal Income Tax - Year % on taxable income from $0 to $9,225, plus 15% on taxable income over $9,225 to $37,450, plus 25% on taxable income over $37,450 to $90,750, plus 28% on taxable income over $90,750 to $189,300, plus 33% on taxable income over $189,300 to $411,500, plus 35% on taxable income over $411,500 to $413,200, plus 39.6% on taxable income over $413,200. Married Joint Filers– Federal Income Tax - Year % on taxable income from $0 to $18,450, plus 15% on taxable income over $18,450 to $74,900, plus 25% on taxable income over $74,900 to $151,200, plus 28% on taxable income over $151,200 to $230,450, plus 33% on taxable income over $230,450 to $411,500, plus 35% on taxable income over $411,500 to $464,850, plus 39.6% on taxable income over $464,850.

Examples of personal tax deductions Mortgage interest Educational expenses Charitable donations Dependents Child care Moving expenses because of job Student loan interest Home office expenses (or other work-related expenses) Certain medical expenses

Quick definition – marginal tax rate: the tax rate on the last dollar of income earned (or what bracket you fall into) Practice problem: An income tax taxes 1% of the first $10,000 of income, 2% on all income from above $10,000 to $30,000, and 4% on all income over $30,000. a. What is the marginal tax rate for someone with an income of $5000? How much total tax does this person pay? How much is this as a percentage of his income? b. What is the marginal tax rate for someone with an income of $20,000? How much total tax does this person pay? How much is this as a percentage of her income? c. What is the marginal tax rate for someone with an income of $50,000? How much total tax does this person pay? How much is this as a percentage of his income?

Warm-up: March 4, 2016 All states impose excise taxes on gasoline. According to data from the Federal Highway Administration, the state of California imposes an excise tax of $0.18 per gallon of gasoline. In 2005, gasoline sales in California totaled 15.6 billion gallons. a. What was California’s tax revenue from the gasoline excise tax? b. If California doubled the excise tax, would tax revenue double? Why or why not?

D. State income tax (3/4/16) Single Filing Status

E. Other taxes 1. Payroll tax: FICA (Social Security and Medicare) a. Proportional tax: same % regardless of income b. Soc Sec: 6.2% up to $118,500 (up from $117,000 in 2014) % total i. Becomes a regressive tax: 2. Medicare: 1.45% (2.9% total) 3. Taxes on corporate profits (progressive)

4. Estate and gift taxes: a. Estate tax: the “death” tax Calendar yearExemptionRate (percentage) 2006$2 million $2 million $2 million $3.5 million repealed0 2011$5 million $5.12 million $5.25 million $5.34 million $5.43 million40

b. Gift tax: 40% on value over $14,000. Example 1: I give you (not my kid) a car valued at $20,000. I owe taxes on $6,000 of it. Example 2: I give my kid a car valued at $20,000. I have to claim it (but as long as lifetime gifts don’t exceed $5.43m, I won’t pay taxes on it) Exclusions: Gifts that are not more than the annual exclusion for the calendar year. ($14000 since 2013) Tuition or medical expenses you pay for someone Gifts to your spouse. Gifts to a political organization for its use.

5. Sales tax a. Varies by state, county (CA: 7.5%; Alameda Co: 9.5%) b. Tends to be regressive: 6. Property tax a. Depends on value of property – flat percentage b. Helps fund schools c. Proposition 13 (1978):

Impact of Prop 13 Average home price in CA, 1975: $41,600 Property taxes paid (1.02%) = $ Value of home cannot increase by more than 2% per year Property taxes 39 years later = 41,600 x (1.02^39) = $901 Value of home for taxation = $90,100 Current average value in 2014 in CA = $424,900 Current property tax for new home = $ If you keep your 1975 home… Home value increased by 10x, but property tax bill only increased by 2x!

Another example: If there was no Prop 13 in California… In the town where I live, median home values have increased 11% from January 2013 to January 2014 Let’s say I bought my home for $1m in 2013 Tax of 1.02% = $10,200 In 2014, my home is re-assessed (increased in value 11%) – now valued at $1.11m Tax of 1.02% = $11, ? $1,232,100 at 1% tax rate = $12, New Jersey? 2.32% (highest in nation) 2013 – 2014 $1m x 2.32% = $23,200 $1.11m x 2.32% = $25,752

7. Excise taxes a. Tax charged on each unit of a good or service sold b. Famous example: the luxury tax of 1991 c. Other examples: Luxury Tax 1991 – 10% on all: Cars sold for more than $30,000 Boats sold for more than $100,000 Jewelry and furs above $10,000 Aircraft above $250,000 Guess what happened?

So, if you impose a tax on either the producer or a consumer of a product…. Will more or fewer products be sold? Will the price consumers pay be more or less than before?

The Supply and Demand for Hotel Rooms in Potterville S D 05,00010,00015,000 $ E B Price of hotel room Quantity of hotel rooms Equilibrium quantity Equilibrium price

An Excise Tax Imposed on Hotel Owners S 1 S 2 A B 05,00010,00015,000 $ Quantity of hotel rooms Price D E Excise tax = $40 per room Supply curve shifts upward by the amount of the tax Tax of $40 imposed. Supply curve shifts upwards by the amount of the tax. New equilibrium = 5000 rooms supplied at $100 per room. Burden of tax shared by hotel and customers (hotel loses $20 per room, customers pay $20 more per room) Tax creates DEADWEIGHT LOSS

An Excise Tax Imposed on Hotel Guests A B 05,00010,00015,000 $ Quantity of hotel rooms E S D 2 D 1 Excise tax = $40 per room Demand curve shifts downward by the amount of the tax Price Tax of $40 imposed on consumers. Demand curve shifts downward by amount of tax rooms supplied at $60 per room. Consumers then pay $40 tax on top of room charge. Burden of the tax again shared by hotels and consumers.

The Revenue from an Excise Tax S B 605,00010,00015,000 $ Quantity of hotel rooms D E Area = tax revenue Excise tax = $40 per room A Price of hotel room The tax revenue collected is: Tax revenue = $40 per room × 5,000 rooms = $200,000 The area of the shaded rectangle is: Area = Height × Width = $40 per room × 5,000 rooms = $200,000

An Excise Tax Paid Mainly By Consumers D S $ Price of gas (per pound) 0 Quantity of gasoline (pounds) Tax burden falls mainly on consumers Excise tax = $1 per gallon When the price elasticity of demand is low and the price elasticity of supply is high, the burden of an excise tax falls mainly on consumers.

An Excise Tax Paid Mainly by Producers D S $ Price of parking space 0 Quantity of parking spaces Tax burden falls mainly on producers Excise tax = $5 per parking space When the price elasticity of demand is high and the price elasticity of supply is low, the burden of an excise tax falls mainly on producers.

A Tax Reduces Consumer and Producer Surplus Q E Quantity S E D Price Q T P E P C P P C A B F Excise tax = T Fall in consumer surplus due to tax Fall in producer surplus due to tax

Deadweight Loss and Elasticities Quantity D E (a) Elastic Demand(b)Inelastic Demand Quantity D S E S Deadweight loss is larger when demand is elastic Q E Q E Q T Q T P E P C P P P E P C P P Excise tax = T Deadweight loss is smaller when demand is inelastic Price

Deadweight Loss and Elasticities (c) Elastic Supply(d)Inelastic Supply Quantity Price D E S Quantity D E S P E P C P P P E P C P P Q E Q E Q T Q T Excise tax = T Deadweight loss is smaller when supply is inelastic Deadweight loss is larger when supply is elastic Price

Deadweight Loss and Elasticities To minimize the efficiency costs of taxation, one should choose to tax only those goods for which demand or supply, or both, is relatively inelastic. For such goods, a tax has little effect on behavior because behavior is relatively unresponsive to changes in the price.