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Section 1: The Economics of Taxation Chapter Introduction Section 1: The Economics of Taxation Section 2: Federal, State, and Local Revenue Systems Section 3: Current Tax Issues and Reforms Visual Summary Chapter Menu

You have just received your first paycheck and are looking forward to being paid $8 per hour for the 20 hours you worked. You look at your check and . . . “What? This check isn’t for $160! Where’s the rest of my money?” Make a list of the deductions that might be subtracted from your earnings. Read Chapter 9 to learn more about how governments raise revenue. Chapter Intro 1

Section Preview Section Objectives: In this section, you will learn that taxes are the most important way of raising revenue for the government. Section Objectives: Students will be able to: Describe the impact taxes have on the economy. Identify the incidence of a tax. Identify and describe the criteria for effective taxes. Describe and give examples of the principles of taxation and the 3 types of taxes. Section 1-Preview

All levels of government use tax revenue to provide essential goods and services. Chapter Intro 2

Economic Impact of Taxes Taxes affect the decisions we make in a variety of ways. Section 1

Economic Impact of Taxes (cont.) Taxes and other governmental revenues influence the economy by affecting Resource allocation Behavior adjustment Sin tax Section 1

Economic Impact of Taxes (cont.) Productivity and growth Determining incidence of a tax Shifting the Incidence of a Tax Section 1

Criteria for Effective Taxes To be effective, taxes must be equitable, easy to understand, and efficient. Section 1

Criteria for Effective Taxes (cont.) Taxes must meet three criteria: Equity—impartial and just: Makes sense to avoid tax loopholes Simplicity—tax laws written so taxpayers and collectors can understand them Individual income tax—complex tax Sales tax—simpler Section 1

Criteria for Effective Taxes (cont.) Efficiency—easy to administer and successful in generating revenue Individuals file a tax return before April 15th each year. Section 1

Two Principles of Taxation Taxes can be levied on the basis of benefits received or the ability to pay. Section 1

Two Principles of Taxation (cont.) United States taxes are based on two principles Benefit principle of taxation Limitations to the benefit principle of taxation Those who receive government services are least likely to afford them. Benefits are hard to measure and impact others. Section 1

Two Principles of Taxation (cont.) Ability-to-pay principle of taxation We can’t always measure benefits derived from government spending. Assumes individuals taxed more suffer less discomfort paying taxes Section 1

Three Types of Taxes All taxes can be broken down into three categories—proportional, progressive, and regressive. Section 1

Three Types of Taxes (cont.) Three general types of taxes exist in the United States today. Proportional tax Imposes the same percentage rate on everyone, regardless of income. The percentage tax rate is constant. Medicare tax fund Tends to hurt the poor and help the rich. Section 1

Three Types of Taxes (cont.) Progressive tax The rate of tax increases as the income earned increases. This type of tax hurts the rich and helps the poor. Federal Income Tax Marginal tax rate Section 1

Three Types of Taxes (cont.) Regressive tax A tax rate that is higher on lower incomes and decreases as income rises. This type of tax favors the rich and hurts the poor. Sales tax and Michigan state income tax Three Types of Taxes Section 1

Section Objectives: Students will be able to: Describe the impact taxes have on the economy. Identify the incidence of a tax. Identify and describe the criteria for effective taxes. Describe and give examples of the principles of taxation and the 3 types of taxes. Section 1-Preview 19

Section 1-End

Section Preview Section Objectives In this section, you will learn that federal, state, and local governments rely on different revenue sources. Section Objectives Students will be able to: Describe why paying taxes is important to the economy. Identify and describe the 3 main sources of Federal governmental revenue. Section 2-Preview

Federal, State, and Local Revenue Systems The Internal Revenue Service (IRS) is the branch of the U.S. Treasury Department in charge of collecting taxes today. Section 2

Federal Government Revenue Sources Individual income taxes, FICA, and borrowing constitute the main sources of government revenue. Section 2

Federal Government Revenue Sources (cont.) Four largest sources of government revenue are Individual income taxes Tax is mostly collected through a payroll withholding system. Tax code takes into account indexing. Federal Government Revenue Sources Section 2

Federal Government Revenue Sources (cont.) FICA or Federal Insurance Contributions Act tax Social Security and Medicare are part of payroll taxes. Borrowing by selling bonds to investors Corporate income tax Excise tax The Global Economy & YOU Total Tax Revenue as a Percentage of GDP Section 2

Federal Government Revenue Sources (cont.) Estate tax and gift tax Customs duty Miscellaneous fees like a user fee Section 2

Section Objectives Students will be able to: Describe the steps necessary to make tax law. Identify and describe the 3 main sources of Federal governmental revenue. Section 2-Preview 28

Section 2-End

Section Preview Section Objectives: In this section, you will learn that one consequence of tax reform was to make the individual tax code more complex than ever. Section Objectives: Students will be able to: Identify and describe a withholding statement. Describe the purpose of tax reforms. Identify and describe alternative approaches to taxation. Section 3-Preview

Examining Your Paycheck The income taxes you pay are summarized on the stub that is attached to your paycheck. Section 3

Examining Your Paycheck (cont.) The payroll withholding statement attached to your paycheck lists deductions taken. Biweekly Paycheck and Withholding Statement Section 3

Federal W – 4 Form

Tax Reform Numerous changes have been made to the federal income tax code since 1981. Section 3

Tax Reform (cont.) The Economic Recovery Tax Act, signed by Ronald Reagan in 1981, included large tax reductions for individuals and businesses. Businesses also got tax relief from accelerated depreciation and investment tax credit. Tax Table for Single Individuals, 2006 Section 3

Tax Reform (cont.) In 1983 the alternative minimum tax was passed. In 1993 government added tax brackets in order to balance the budget. The Taxpayer Relief Act of 1997 was both economical and political. Capital gains tax was reduced. Total Government Receipts per Capita, Adjusted for Inflation Section 3

Tax Reform (cont.) Temporary tax reform in 2001—based on the federal government collecting more taxes than it was spending Temporary tax reform in 2003—due to slow economic growth, accelerated many of 2001 reforms If the present trend of government spending more than it collects in taxes continues, it will be difficult to preserve tax cuts due to expire in 2011. Section 3

What do you think Congress should do now regarding taxes? A. Keep everything the same B. Reduce government spending C. Increase taxes D. Change the tax structure all together A B C D Section 3

Alternative Tax Approaches The need for new federal revenues will influence future tax reform. Section 3

Alternative Tax Approaches (cont.) Two alternative forms of taxation Flat tax Value-added tax (VAT) The Value-Added Tax Section 3

Alternative Tax Approaches (cont.) Advantages to the flat tax Simplicity to taxpayer Closes most loopholes Reduces need for many workers in IRS and tax preparers Section 3

Alternative Tax Approaches (cont.) Disadvantages to the flat tax Removes many incentives built into current tax code Don’t know what rate is needed to replace revenues collected today Unsure if flat tax would stimulate economic growth Section 3

Alternative Tax Approaches (cont.) Advantages to the VAT Tax is hard to avoid Tax incidence is widespread Easy to collect Encourages saving Section 3

Alternative Tax Approaches (cont.) Disadvantage to the VAT Virtually invisible—other factors can change the product’s price. Desires to simplify the tax code, unexpected expenditures on war and natural disasters, and political change all result in tax reform. Section 3

Why is it difficult for politicians to change the tax code completely? A. Hard to give up power of modifying behavior and influencing allocation of resources B. They support their own pet projects. C. They find it hard to grant concessions to special interest groups. D. All of the above A B C D Section 3

Section Objectives: Students will be able to: Identify and describe a withholding statement. Describe the purpose of tax reforms. Identify and describe alternative approaches to taxation. Section 3-Preview 46

Section 3-End

Types of Taxes All taxes in the United States can be broken down into three categories: proportional, progressive, and regressive VS 1

Government Revenue Sources Federal, state, and local revenue sources differ. Much of the federal revenue is sent on to state and local governments. VS 2

Alternative Tax Approaches Because the federal tax code has become so large and cumbersome, people have discussed the flat tax and the value-added tax as two alternatives. VS 3

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Monica Garcia Pleiman (1964– ) president and CEO of OMS, a technology consulting firm publisher of Hispanic lifestyles magazine Latino SUAVE cofounder of the Latina Chamber of Commerce Profile

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sin tax relatively high tax designed to raise revenue and discourage consumption of a socially undesirable product Vocab1

incidence of a tax final burden of a tax Vocab2

tax loophole exception or oversight in the tax law allowing taxpayer to avoid paying certain taxes Vocab3

individual income tax federal tax levied on the wages, salaries, and other income of individuals Vocab4

sales tax general state or city tax levied on a product at the time of sale Vocab5

tax return annual report by a taxpayer filed with local, state, or federal government detailing income earned and taxes owed Vocab6

benefit principle of taxation belief that taxes should be paid according to benefits received regardless of income Vocab7

ability-to-pay principle of taxation belief that taxes should be paid according to level of income, regardless of benefits received Vocab8

proportional tax tax in which percentage of income paid in tax is the same regardless of the level of income Vocab9

average tax rate total taxes paid divided by the total taxable income Vocab10

Medicare federal health-care program for senior citizens Vocab11

progressive tax tax in which the percentage of income paid in tax rises as the level of income rises Vocab12

marginal tax rate tax rate that applies to the next dollar of taxable income Vocab13

regressive tax tax in which the percentage of income paid in tax goes down as income rises Vocab14

validity justification Vocab15

evolved developed gradually Vocab16

Internal Revenue Service (IRS) branch of the U.S. Treasury Department that collects taxes Vocab17

payroll withholding system system that automatically deducts income taxes from paychecks on a regular basis Vocab18

indexing adjustment of tax brackets to offset the effects of inflation Vocab19

FICA Federal Insurance Contributions Act; tax levied on employers and employees to support Social Security and Medicare Vocab20

payroll tax tax on wages and salaries deducted from paychecks to finance Social Security and Medicare Vocab21

corporate income tax tax on corporate profits Vocab22

excise tax general revenue tax levied on the manufacture or sale of selected items Vocab23

estate tax tax on the transfer of property when a person dies Vocab24

gift tax tax paid by the donor on transfer of money or wealth Vocab25

customs duty tax on imported products Vocab26

user fee fee paid for the use of good or service Vocab27

intergovernmental revenue funds that one level of government receives from another level of government Vocab28

property tax tax on tangible and intangible possessions such as real estate, buildings, furniture, stocks, bonds, and bank accounts Vocab29

tax assessor person who examines and assesses property values for tax purposes Vocab30

natural monopoly market structure in which average costs of production are lowest when a single firm exists Vocab31

implemented put into effect Vocab32

considerably to a noticeable or significant extent Vocab33

payroll withholding statement document attached to a paycheck summarizing pay and deductions Vocab34

accelerated depreciation schedule that spreads depreciation over fewer years to generate larger tax reductions Vocab35

investment tax credit tax credit given for purchase of equipment Vocab36

alternative minimum tax personal income tax rate that applies to cases in which taxes would otherwise fall below a certain level Vocab37

capital gains profits from the sale of an asset held for 12 months or longer Vocab38

flat tax proportional tax on individual income after a specified threshold has been reached Vocab39

value-added tax (VAT) tax on the value added at every stage of the production process Vocab40

concept general idea Vocab41

controversial disputed Vocab42

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