Economics Chapter 12: Taxes and taxation Who and What Should be Taxed?

Begin with a story… St. Valentine’s Day 1929 Results of the incident? Anyone know what happened? Results of the incident? What eventually brought this person to justice?

Taxes! Ben Franklin’s immortal words… What are taxes? “The price of civilization”—Oliver Wendell Holmes, Jr. Been around since earliest civilizations Support services and infrastructure Promote social and economic goals What has been our national history towards taxes?

What does Adam Smith say? Four guiding principles: Equity: Taxes should be fair “Not unreasonable that the rich should contribute to the public expense, not only in proportion to their revenue, but something more than in that proportion.” Certainty: Time, manner, and quantity all known up front Convenience: System should not be complicated Efficiency: Keep economic cost of taxes to a minimum

Tax Equity Debate: Who Pays and Why? Economists agree that the system should be fair, but they disagree over how to achieve fairness 2 basic approaches Ability to Pay Principle Benefits Received Principle Which one do you think is the proper way to achieve fairness? Turn to a partner and discuss.

Who Ends Up Paying? Economic burden of a tax is known as “Tax Incidence” May not always fall on the person who pays the tax bill Think hotel rooms and “occupancy taxes” Tax Incidence is affected by the elasticity of supply and demand In general, tax will fall on the side of the market that is less elastic

What Taxes Will You Pay? Important date to know---April 15---filing deadline Tax Base---the thing that is taxed Personal income or property tax as examples Tax Rate---percentage of the value of the good (property or income) that is paid in tax Example: 20% income tax rate Look at current tax rates, Federal and Virginia

Tax Structures Proportional Tax---same share of income at all levels Sometimes called a “Flat Tax” Critics cite fairness as an issue---ability to pay Advocates say that it is inherently fair Slovakia has this---19% income tax for all Tradeoff: Less tax evasion, greater foreign investment/less money for government services

Tax Structures Progressive Tax---takes a larger share of income as income increases Based on ability to pay principle Structure for most federal taxes Critics say it places unequal burden on rich--- fundamentally unfair (punishes rich for being rich) Creates disincentive to work, save, and invest Also say it creates a more complicated system

Tax Structures Regressive Tax---tax that takes a smaller share of income as income increases No government really sets out to do this…but it sometimes happens Example---Proportional tax called a “sales tax” Tax on what you spend 20k earned; spends 10k to live; tax rate 5% = $500 Represents 2.5% of low earner’s income 100k earned; spends 30k to live; rate of 5% = $1,500 Represents 1.5% of high earner’s income

Taxes You Will Pay Individual Income Tax---Marginal (pg. 239) Payroll Tax---Tax on wages a company pays its employees (examples---Social Security and Medicare) Social Security Tax---paid ½ by you, ½ by employer 2008---Social Security tax rate was 12.4% What type of tax is this? Property Tax---assessed value Sales Tax---purchase of a good Corporate Income Tax---profits Excise Taxes---Things gov. wants to regulate Luxury Taxes---private jets, fur coats, etc. Estate and Inheritance Tax

Taxes are Revenue; How does Gov. Spend it? 2007 Tax Revenue for the government $2,500,000,000,000----$2.5 Trillion Four sources---income, payroll, corporate, excise (in order) Does not take in enough to cover all expenses---- federal deficit Thus, government borrows money National debt is the total amount owed as a result of borrowing

Federal Spending Mandatory vs. Discretionary Mandatory Discretionary Spending is fixed by law Entitlements and interest on national debt Entitlements include Social Security, Medicare, welfare Mandatory spending in 2010 approx. 65% of federal rev. Discretionary May be raised or lowered as Congress sees fit National defense