Income Tax Base and Rates

Principles of Sound Tax Policy Adequacy Neutrality Fair or equitable Horizontal Vertical Ease of Administration and Compliance Accountability Administration and enforcement should be efficient and fair Government must enforce the laws Open, transparent tax policy

Tax Base and Rates Tax rates Computation Statutory Effective Computation Average Effective Average Marginal Tax classifications based on average tax rates relative to gross income Regressive Proportional or flat Progressive

Overview of Tax Calculations The U.S. definition of taxable income Adjusted gross income (AGI) Excluded forms of money income Taxable income (TI) Exemptions and deductions

Adjusted Gross Income (AGI) AGI = wages + salaries + tips + interest income + dividend income + capital gains + net business/farm income – adjustments.

Excluded Forms of Money Income Interest earnings on municipal bonds. Employer contributions to benefit plans, e.g. medical/dental/vision insurance. Contributions to retirement savings plans, e.g. pension contributions, IRA contributions, KEOGH contributions.

Taxable Income (TI) TI = AGI – personal exemptions – deductions. Deductions may be either the standard deduction or itemized deductions.

Deductions are permitted for: Medical and dental care--expenditures in excess of 7.5% of AGI may be deducted Taxes paid, including state and local income taxes, real estate taxes, and personal property taxes (sales tax ?) Interest paid, including home mortgage interest and investment interest Gifts to charity, including cash gifts and other than cash gifts Casualty or theft loss Job expenses, including un-reimbursed employee expenses, job travel, union dues, and job educational expenses Other miscellaneous expenses (including tax preparation fees

APPLICATION: What Are Appropriate Business Deductions? Hard to determine appropriate business deductions: A rabbi claimed as a business expense the $4,031 he spent on 700 guests who attended his son’s bar mitzvah. Tax court found the Rabbi “was not required to invite the entire…congregation…as a condition of his employment.” The entertainer Dinah Shore claimed several dresses as business expenses, prompting an investigation by the IRS. “Dinah Shore ruling”: A dress may be deducted as a business expense only if it is too tight to sit in.

APPLICATION: What Are Appropriate Business Deductions? A man tried to deduct $30,000 in expenses on illegal drugs. Allowed to claim deductions, he was sentenced for criminal charges. Many OECD countries have traditionally allowed/ treated foreign bribes as business expenses.

Income Tax Rate Structures The U.S. income tax has a progressive rate structure. Current tax rates range from 10% to 39.6%. Table of personal income tax brackets Source: Urban Institute and Brookings Institute

Figure 13.1: Tax Rates for a Single Filers, 2001

Figure 13.2: Tax Rates for Married Couples Filing Jointly, 2001 Copyright © by Houghton Mifflin Company. All rights reserved.

U.S. Federal Income Tax Rate Schedule, 2012 18.2 U.S. Federal Income Tax Rate Schedule, 2012