How Taxes Work Economics

Focus Questions Why does the government establish taxes? What are the principles of taxes? What is the structure of taxes? What is the incidence of taxes? How do taxes impact the economy? To provide for certain public goods not provided by the market and to provide for people in need

Government Revenue Taxes provide the government with money for public goods that are not generally provided by the market (lighting, highways, law enforcement, court system) Taxes provide aid for people in need

Principles of Taxes Benefits-Received Principle: people who benefit directly should pay directly in proportion based on benefits received. example- paying for highway improvements with gasoline tax Ability-to-Pay Principle: people should be taxed on their ability to pay, regardless of how much of the benefit they receive example- people with higher incomes will pay more than people with lower incomes

Structure of Taxes Proportional Tax: flat tax-rate is the same for everybody; example-everybody pays a 15% income tax (some state/local governments) Progressive Tax: taxes increase as income increases (federal income tax) Regressive Tax: taxes decrease with higher incomes (sales taxes)

Incidence of Taxes Incidence of a Tax: the final burden of the tax or the impact of the tax on the taxpayer (taxes imposed on businesses may get passed on to the consumer) Elasticity on Taxes: inelastic- the buyer pays more of the percentage of the tax in the price, in elastic demand the seller pays more of the price of the tax

Impact on the Economy Resource Allocation: occurs when a producer shifts production to another resource when they are unable to pass a higher price on to the consumer...because it is more profitable Productivity and Growth: higher taxes may deter a strong work ethic Economic Behavior: the government can attempt to control the economy by providing tax incentives or tax credits and rebates to stimulate the economy