Chapter 6, Section 3 Fairness in Taxes Part 1: Fairness & Tax Structures Part 2: Calculating Taxes Part 3: What is a Fair Tax Policy? Mr. Vasu – Honors Economics

Chapter 6, Section 3 Fairness in Taxes: Objectives 1. Identify different taxes levied by the government 2. Determine the fairness of taxes using ability- to-pay and benefits received 3. Define progressive, regressive and proportional tax structures 4. Analyze the fairness of different tax structures on different families

Chapter 6, Section 3 Why do we need Taxes? 1. Government has expenses: 1. Provide public goods/market failures 2. Wealth redistribution programs 3. Promote employment, growth and stability 2. Government needs revenue to pay for expenses Government levies taxes (collects) Government levies taxes (collects)

Chapter 6, Section 3 Fairness in Taxes: 2 Perspectives Fairness in taxes is defined by two opposing perspectives: Ability to pay Ability to pay You pay taxes based on what you can afford You pay taxes based on what you can afford Wealthier people should pay higher tax rates Wealthier people should pay higher tax rates Income Tax, Estate Tax Income Tax, Estate Tax Used to fund public goods/non-rival goods everyone uses Used to fund public goods/non-rival goods everyone uses Benefits received Benefits received People who use goods/services should pay the taxes People who use goods/services should pay the taxes Used to fund government-funded G&S not used by all Used to fund government-funded G&S not used by all Toll road; National Park fees; Parcs&Rec Gym fees Toll road; National Park fees; Parcs&Rec Gym fees Sales Tax, Excise Tax (gas/tobacco/alcohol) Property Tax, Capital Gains Tax & FICA Tax Sales Tax, Excise Tax (gas/tobacco/alcohol) Property Tax, Capital Gains Tax & FICA Tax

Chapter 6, Section 3 1. Is it easy to figure out who is using a government good or service? 1. Yes – Whoever receives benefit should pay tax 2. No – Whoever has ability to pay should pay tax Should wealthier people pay the burden of the tax? Should wealthier people pay the burden of the tax? Yes – Whoever has ability to pay should pay tax Yes – Whoever has ability to pay should pay tax No – Whoever receives benefit should pay tax No – Whoever receives benefit should pay tax Fairness in Taxes: 2 Perspectives In deciding who pays and whether it is fair, answer these two questions

Chapter 6, Section 3 Mr. Vasu rides his bike to work. Ms. Ostanski drives her car to work. Justify how this tax is fair for the taxpayers? They both pay income tax, since they have middle-class jobs, which is used to fund the roads and other public goods in Chicago They both pay income tax, since they have middle-class jobs, which is used to fund the roads and other public goods in Chicago Ms. Ostanski pays a gas tax (used to fund clean energy and public transit) whenever she fills up her car. Mr. Vasu does not pay this tax. Ms. Ostanski pays a gas tax (used to fund clean energy and public transit) whenever she fills up her car. Mr. Vasu does not pay this tax. Mr. Vasu pays an annual fee to use the city parks gyms, like Welles and Margate Park Mr. Vasu pays an annual fee to use the city parks gyms, like Welles and Margate Park Fairness in Taxes: Check 4 Understanding Ability-to-Pay: Public goods are shared by all. They can afford the tax Benefits Received Ms. O is using the gas, so she should pay tax for it. Benefits Received Mr. Vasu is using the gym, so he should pay for it.

Chapter 6, Section 3 Tax Structures and Bases 1. The tax structure determines how equally the tax is paid by taxpayers 2. There are three major tax structures: Progressive Taxes Progressive Taxes Regressive Taxes Regressive Taxes Proportional Taxes Proportional Taxes 3. A tax structure is applied to a tax base: income, wealth, property, goods/services income, wealth, property, goods/services

Chapter 6, Section 3 Progressive Tax Tax rate increases as income increases Tax rate increases as income increases Example: Federal Income tax Example: Federal Income tax Ability to pay fairness: wealthier people pay both higher tax rates and tax amounts Ability to pay fairness: wealthier people pay both higher tax rates and tax amounts

Chapter 6, Section 3 Regressive Tax Tax rate decreases as income increases (affects poorer more) Tax rate decreases as income increases (affects poorer more) Opposite effect of progressive tax Opposite effect of progressive tax Tax on goods/services that are a major portion of low-income people’s budgets Tax on goods/services that are a major portion of low-income people’s budgets Examples: Sales Tax, Gas tax, Sin tax, FICA tax Examples: Sales Tax, Gas tax, Sin tax, FICA tax Benefits received fairness – if you use it, you pay tax for it Benefits received fairness – if you use it, you pay tax for it ItemAmount % of Income Rent$60035% Gas$40024% Food$40024% Consumer A (Mo. Inc. $1,700; 100gal Gas)ItemAmount % of Income Rent$100025% Gas$40010% Food$60015% Consumer B (Mon. Inc. $4,000; 100gal Gas)

Chapter 6, Section 3 Proportional Tax Tax rate is the same for everyone Tax rate is the same for everyone Tax revenue will vary depending on the tax base Tax revenue will vary depending on the tax base Examples: Capital Gains tax, Illinois State Income tax, Examples: Capital Gains tax, Illinois State Income tax, Simple and easy to understand Simple and easy to understand Bi-Weekly Income Earned $50 Payroll Tax Rate 4% Payroll Tax Amount $2 Employee AEmployee B Bi-Weekly Income Earned $3,000 Payroll Tax Rate 4% Payroll Tax Amount $120

Chapter 6, Section 3 Tax Structures: Check 4 Understanding 1. The income tax rate that people pay increases as people make more money. Income tax rate is 10% if a single person makes less than $8,500 per year, while it is 25% for someone who earns $50,000. Is this tax structure progressive, regressive or proportional? Why? 2. The government is considering levying a tax on low- cost, but unhealthy food items like chips, soda and fast food, 1. Would this tax be progressive, regressive or proportional? Why? 2. Is the tax still fair/justified? Why/Why not?

Chapter 6, Section 3 Calculating Income Taxes Federal Income Tax is a Progressive Tax Federal Income Tax is a Progressive Tax Tax rate increases as income increases Tax rate increases as income increases The tax structure is provided by the Federal Income Tax Brackets and Marginal Tax Rates The tax structure is provided by the Federal Income Tax Brackets and Marginal Tax Rates Marginal tax rates only apply to a specific marginal tax base Marginal tax rates only apply to a specific marginal tax base To calculate individual federal income tax, you will need the tax base To calculate individual federal income tax, you will need the tax base Tax base: income in one year (from W2 forms) Tax base: income in one year (from W2 forms) Total tax amount is the sum of the marginal tax amounts Total tax amount is the sum of the marginal tax amounts Multiply the marginal tax rate by the tax bracket amount Multiply the marginal tax rate by the tax bracket amount

Chapter 6, Section 3 Calculating Income Taxes The marginal tax rate is only applied to each marginal tax base The marginal tax rate is only applied to each marginal tax base Overall tax rate = total tax amount Overall tax rate = total tax amount annual income

Chapter 6, Section 3 Calculating Income Taxes

Chapter 6, Section 3 Calculating Income Taxes: Tax Tower 10% $0 Marginal Tax rate Marginal Tax Base Marginal Tax Amount $8,700 $35,530 $85,650 $95,000 $8,700 $26,830 $50,120 $8,350 15% 25% 28% Tax Rate * Tax Base = $870 $4, $12,530 $2,338 Total Tax Amount $17, % of $8,350 = $2,338 $17, ,338 Total Tax Amount$19, ,762.50/95,000 Overall Tax Rate20.8% Single Filer with Annual Income of $95,000 in 2012 This is given in Tax Brackets

Chapter 6, Section 3 Calculating Income Taxes What is the overall tax amount for someone filing as single who earns $60,000 per year? What is the overall tax amount for someone filing as single who earns $60,000 per year? What is the overall tax rate? What is the overall tax rate? 10% $8,700 $35,530 15% 25% $870 $4,024.50$4, Marginal Tax rate Marginal Tax Base Marginal Tax Amount $60,000 Total Tax Amount $8,700 $26,830 $24,470 $6, % of $24,470 = $6, Total Tax Amount $10,985 10,985/60,000 Overall Tax Rate18.3% This is given in Tax Brackets

Chapter 6, Section 3 Tax Expenditures: Gross vs. Taxable Income So far, we assumed the taxpayers would pay tax on all the income earned in one year (gross income) So far, we assumed the taxpayers would pay tax on all the income earned in one year (gross income) Taxpayers only pay tax on their taxable income Taxpayers only pay tax on their taxable income The government allows taxpayers to lower or reduce the amount of income they owe tax on The government allows taxpayers to lower or reduce the amount of income they owe tax on These are tax expenditures (they reduce government revenues) These are tax expenditures (they reduce government revenues) Deductions and Exemptions lower taxable income Deductions and Exemptions lower taxable income Taxable income is less than gross income Taxable income is less than gross income

Chapter 6, Section 3 Tax Expenditures: Deductions Subtracted from gross income Subtracted from gross income Taxpayers can choose either the standard deduction or to itemize individual deductions Taxpayers can choose either the standard deduction or to itemize individual deductions Standard deduction is $5,950 for single and $11,900 for joint filers in 2012 Standard deduction is $5,950 for single and $11,900 for joint filers in 2012 Choose itemize if individual deductions will be greater than the standard deduction Choose itemize if individual deductions will be greater than the standard deduction Common itemized deductions include: mortgage payments, property tax, uninsured medical expenses, charitable contributions Common itemized deductions include: mortgage payments, property tax, uninsured medical expenses, charitable contributions

Chapter 6, Section 3 Exemptions Exemptions Subtracted from gross income Subtracted from gross income Everyone qualifies for a $3,800 exemption Everyone qualifies for a $3,800 exemption Credits Credits Subtracted directly from taxes owed Subtracted directly from taxes owed Common credits include for education expenses and incentives Common credits include for education expenses and incentives Tax Expenditures: Exemptions and Credits

Chapter 6, Section 3 Income vs. Capital Gains Tax Marginal income tax rates are higher than capital gains tax for most individuals Marginal income tax rates are higher than capital gains tax for most individuals Capital Gains tax is only 15% Capital Gains tax is only 15% Many high-income individuals’ annual earnings comes in the form of capital gains and not income Many high-income individuals’ annual earnings comes in the form of capital gains and not income They generate income from savings/investments much more than lower-income individuals They generate income from savings/investments much more than lower-income individuals Stock options, dividends, equity payouts, interest earnings Stock options, dividends, equity payouts, interest earnings Income taxes are not as progressive when the wealthiest people don’t pay income tax! Income taxes are not as progressive when the wealthiest people don’t pay income tax!

Chapter 6, Section 3 Key Terms Ability to pay: People with different amounts of wealth or income should pay tax at different rates Ability to pay: People with different amounts of wealth or income should pay tax at different rates Benefits received: People should pay taxes based on the benefits they receive from government goods and services Benefits received: People should pay taxes based on the benefits they receive from government goods and services Progressive tax: Tax for which the percentage of income paid in taxes increases as income increases Progressive tax: Tax for which the percentage of income paid in taxes increases as income increases Proportional tax: A tax for which the percentage of income paid in taxes remains the same at all income levels Proportional tax: A tax for which the percentage of income paid in taxes remains the same at all income levels

Chapter 6, Section 3 Key Terms Regressive tax: A tax for which the percentage of income paid in taxes decreases as income increases Regressive tax: A tax for which the percentage of income paid in taxes decreases as income increases Tax base: the income, wealth, property, good or service that is being taxed Tax base: the income, wealth, property, good or service that is being taxed Income tax: Tax on income, or revenue earned from wages; individuals and companies pay income tax Income tax: Tax on income, or revenue earned from wages; individuals and companies pay income tax Tax bracket: Based on income level, the category of income tax an individual qualifies for Tax bracket: Based on income level, the category of income tax an individual qualifies for Marginal Tax Rate: the tax rate at the highest tax bracket an individual’s income qualifies for Marginal Tax Rate: the tax rate at the highest tax bracket an individual’s income qualifies for

Chapter 6, Section 3 Key Terms Capital Gains tax: Tax on wealth, such as interest, dividends and gains on stock and other asset sales; levied mostly on high income people Capital Gains tax: Tax on wealth, such as interest, dividends and gains on stock and other asset sales; levied mostly on high income people Property tax: A tax based on real estate and other property Property tax: A tax based on real estate and other property Sales tax: Tax on goods or services that are sold Sales tax: Tax on goods or services that are sold Excise/Sin tax: high sales tax rates on tobacco, alcohol and gambling; levied disproportionately on low income people Excise/Sin tax: high sales tax rates on tobacco, alcohol and gambling; levied disproportionately on low income people FICA tax: Tax that all US workers must pay to fund Social Security/Medicare and other retirement benefits programs. Benefits received tax. Regressive tax since it is not paid on income earned over $100k. FICA tax: Tax that all US workers must pay to fund Social Security/Medicare and other retirement benefits programs. Benefits received tax. Regressive tax since it is not paid on income earned over $100k.