TAXES: The main source of government revenue

The Economics of Taxation  In addition to creating revenue for the government, taxes also impact the economy in the following ways:  Resource allocation - if taxes are too high, supply will decrease and /or prices will increase causing a shift in the allocation of land, labor and capital.  Behavior adjustment - sin taxes, such as those placed on cigarettes attempt to change a person’s behavior  Productivity and Growth - if taxes are too high, there is less incentive for people or businesses to continue to grow. Why earn more if most of it is taken away in higher taxes?  In addition to creating revenue for the government, taxes also impact the economy in the following ways:  Resource allocation - if taxes are too high, supply will decrease and /or prices will increase causing a shift in the allocation of land, labor and capital.  Behavior adjustment - sin taxes, such as those placed on cigarettes attempt to change a person’s behavior  Productivity and Growth - if taxes are too high, there is less incentive for people or businesses to continue to grow. Why earn more if most of it is taken away in higher taxes?

Incidence of a Tax  Who bears the final burden of this tax?  If there is a relatively inelastic demand curve the burden can be shifted to the consumer.  It there is a relatively elastic demand curve, the producer will absorb the tax.  Who bears the final burden of this tax?  If there is a relatively inelastic demand curve the burden can be shifted to the consumer.  It there is a relatively elastic demand curve, the producer will absorb the tax.

To be effective Taxes must meet the following criteria:

TWO PRINICPLES of TAXATION  “Who pays What” is based on two principles:  Benefit Principle - The more you benefit from something, the more you should pay. Taxes on gasoline  Ability to Pay - The more you make the more you should pay.  “Who pays What” is based on two principles:  Benefit Principle - The more you benefit from something, the more you should pay. Taxes on gasoline  Ability to Pay - The more you make the more you should pay.

Types of Taxes  Taxes are classified according to the ay in which the tax burden changes as income changes.  Proportional Tax  Progressive Tax  Regressive Tax  Taxes are classified according to the ay in which the tax burden changes as income changes.  Proportional Tax  Progressive Tax  Regressive Tax

Proportional Taxes  Regardless of Income, the same tax rate is imposed upon everyone. Another term for a proportional tax is a flat tax.  If there is a 20% flat tax, how much do you pay in taxes if you earn $10,000? What if you earn $100,000?  Note as a person’s income increases, the percentage of total income paid in taxes remains the same.  Property Tax is a proportional tax.  Regardless of Income, the same tax rate is imposed upon everyone. Another term for a proportional tax is a flat tax.  If there is a 20% flat tax, how much do you pay in taxes if you earn $10,000? What if you earn $100,000?  Note as a person’s income increases, the percentage of total income paid in taxes remains the same.  Property Tax is a proportional tax.

Proportional Tax Income 10,00050,000100,000 Tax Rate 40% 20% 10%

Progressive Tax  People with higher incomes pay a higher percentage in taxes. Federal and State income tax are progressive taxes. INCOMEAmount Paid in Taxes Amount Paid as a percentage of Income $10,000$1,00010% $50,000$ 10,00020% $100,000$ 30,00030%

Progressive Tax Income 10,00050,000100,000 Tax Rate 40% 20% 10%

Regressive Taxes  The lower the income the higher percentage paid in taxes.  Sales tax is an example of a regressive tax. Assume two families paid $1000 in sales tax by the end of the year. Which family spent a higher percent of their income on taxes?  The lower the income the higher percentage paid in taxes.  Sales tax is an example of a regressive tax. Assume two families paid $1000 in sales tax by the end of the year. Which family spent a higher percent of their income on taxes? IncomeAmount paid in taxes Amount paid in taxes as a percentage of their income. $10,000$ % $50,000$ %

Regressive Tax Income 10,00050,000100,000 Tax Rate 40% 20% 10%

FEDERAL TAXES Amendment 16 gives Congress the power to lay and collect taxes. Federal Income Taxes are due April 15. In 2006, Tax Freedom Day was April 26, this is day you will have earned enough money to pay for all you federal, state and local taxes. In 2004, an estimated 45% of the federal budget came from individual income tax.

Income Tax  Individual income taxes are paid over time through a payroll withholding system (just look at your paycheck). By April 15, you must file a tax return. Any difference in the amount paid compared to the amount owed is settled at this time.  From an economist’s point of view, is it better to owe money to the IRS or receive a refund check? WHY?  Individual income taxes are paid over time through a payroll withholding system (just look at your paycheck). By April 15, you must file a tax return. Any difference in the amount paid compared to the amount owed is settled at this time.  From an economist’s point of view, is it better to owe money to the IRS or receive a refund check? WHY?

More Federal Taxes  FICA - Federal Insurance Contributions Act  Social Security and Medicare  Corporate Income Tax - As a separate legal entity, corporations are taxed.  Excise Tax - tax on the manufacture or sale of selected items  Estate Tax - tax (18-50%) on the transfer of property upon a death. As of 2006, estates worth less than 2 million dollars are exempt.  Gift Tax - Tax on money donations, paid by the person donating.  Customs Duties: Tax on imported goods. Exported goods may not be taxed.  FICA - Federal Insurance Contributions Act  Social Security and Medicare  Corporate Income Tax - As a separate legal entity, corporations are taxed.  Excise Tax - tax on the manufacture or sale of selected items  Estate Tax - tax (18-50%) on the transfer of property upon a death. As of 2006, estates worth less than 2 million dollars are exempt.  Gift Tax - Tax on money donations, paid by the person donating.  Customs Duties: Tax on imported goods. Exported goods may not be taxed.

State Taxes and Local Taxes  Intergovernmental Revenues - transfer of money from the federal government  Sales Tax  Employee Retirement Contributions  Individual Income Tax  Intergovernmental Revenues - transfer of money from the federal government  Sales Tax  Employee Retirement Contributions  Individual Income Tax  Intergovernmental Revenues -from state level  Property Tax  Public Utility or State owned liquor stores  Sales Tax - this varies from city to city!  Intergovernmental Revenues -from state level  Property Tax  Public Utility or State owned liquor stores  Sales Tax - this varies from city to city!