Taxes and Taxation

Why are there taxes? Main Reason: To raise revenue for the government

What are some other reasons for taxation? To encourage some kinds of economic activity To discourage consumption of items (alcohol, tobacco) To reprice items in the economy. I.e. Farmer subsidies are paid by taxpayers. To redistribute income and/or wealth.

If taxes are a necessary evil, what principles should guide the design of a good tax system?

Adam smith and his four principles of taxation 1. equity (fairness) 2. certainty or predictability 3. convenience (for the contributor to pay the tax) 4. efficiency

Equity Equity in taxation concerns fairness, the idea the tax system should be fair. Two different, competing criteria. 1. The ability to pay principle. People with higher incomes should pay more tax. 2. The benefits received principle. Those who benefit from a particular government program should pay for it.

Deadweight loss of taxation (cause by an inefficient tax) “ A deadweight loss occurs when the cost to consumers and producers from a tax – due to lost productivity or sales – is larger than the size of the tax revenue it generates.” (Econ Alive, p. 235) A deadweight loss usually means that someone is worse off (in terms of cost) while no one is better off (in terms of benefit)

Different types of taxation Proportional taxes Progressive taxes Regressive taxes

Proportional (or flat) tax It is a tax that takes the same share of income at all income levels. i.e. income tax is at 20% Bill Gates and a worker at a fast food restaurant would tax at the same rate. Advantage: Simpler to figure our and administer than other kinds of taxes. Disadvantage: Fairness; Billionaires and poor people would pay tax at the same rate.

Progressive tax A tax that takes a larger share of income as income increases. Based on the ability to pay principle. Supporters of progressive taxes say that it is fairer.

Regressive tax A tax that takes a smaller share of income as income increases. A proportional tax can also be regressive if it takes a bigger bite out of the incomes of poor people than rich people. A sales tax is usually regressive. A VAT (or value-added tax) is often regressive also.

Different kinds of taxes

Income tax (personal and corporate) Personal Income Tax is a tax assessed on someone’s annual income It can be levied by federal, state, and local gov’ts At the federal level it is a progressive tax. Corporate income tax is applied to the profits of corporations. It is progressive at the federal level. Critics allege that is tax is passed on to consumers. Critics also say this tax is too high in the U.S.

Inheritance (or estate) tax A tax that is levied on some or all of the estate (property and possessions) that a person leaves behind at death. Their heir must pay the tax. Estate taxes are progressive; the more you inherit, the higher the rate of tax.

Luxury tax and excise tax Luxury: levied on the sale of luxury items (yachts and private jets,e.g.) They are progressive taxes. Excise: usually levied on goods the government wants regulate (e.g., alcohol and tobacco). These taxes are sometimes called sin taxes. They are generally regressive taxes.

Property tax Commonly levied on real estate (buildings, land, etc…) Some states levy them on cars, motorcycles and boats. i.e. Loudoun County They are a major source of school funding.

Sales tax Paid for by the customer when he or she purchases various goods or services. Generally regressive. Levied by states and some cities.

User fees and tolls Charged for the use of public facilities and services. Also required for permits and licenses.

Different parts of the federal budget Composed of two main parts: Mandatory spending and discretionary spending. What does mandatory spending mean? What does discretionary spending mean?

Fixed or mandatory spending (entitlements, etc.) Mandatory spending are gov’t expenditures that are fixed by law and can only be changed by new laws. i.e. social security, Medicare, interest on national debt and food stamps.

Discretionary spending Expenditures that can be raised or lowered as a legislature see fit. i.e. military or defense, education.

These expenditures are made over a fiscal year Fiscal year is a 12 month accounting period that is used by businesses and other organizations. The federal government begins it fiscal year every on October 1st.

Problems with the federal budget What are some of the main problems with the federal budget? 1. expenses exceed revenues. 2. long-term debt is getting worse. 3. Too much is spent on some things and not enough on others. (opinions will vary.)

What are some possible solutions to the long-term budget deficit? Cut expenses Increases revenue (via tax increases, etc..)

State and local taxes and expenditures State and local budgets reflect different priorities and obligations compared to the federal budget. For one thing, they devote a significant portion of their budget to education.

Crash Course - Taxes https://www.youtube.com/watch?v=7Qtr_vA3Prw

Class work Looking at our notes what kind of tax would you use and why? Looking at our notes, what would you cut in our federal budget? Is there a certain product or item that the government could tax to raise revenue?