U.S. Tax System Effects of tax depend upon how it interacts with other taxes U.S. has federal tax system 3 major categories of U.S. tax system: Federal taxes State taxes Local taxes

Federalism and the Tax System Federal government collects more in revenues than all other U.S. governments combined Income tax primarily a federal tax Property tax primarily a local tax Sales taxes primarily state taxes

Federalism and the Tax System

Federal Taxes Personal income tax most significant source of federal government revenue Social insurance payroll taxes Social security tax structure is regressive

Federal Taxes

Intergovernmental Revenues Major revenue source for lower-level governments Most significant intergovernmental revenues consist of federal aid to state/local governments State governments provide assistance to local governments

Intergovernmental Revenues Can have significant effects on government finance Can substitute for own-government taxation Most come from higher-level governments to lower-level governments

Intergovernmental Revenues Reasons to establish intergovernmental programs: Higher-level governments provide money to encourage certain programs by lower-level governments Taxation for lower-level governments can be shifted to higher-level governments Equity

State and Local Taxes States rely on sales and income taxes Local governments rely on property taxes Sales and income taxes have risen faster than property taxes

State and Local Taxes

Progressivity of Tax System Important to consider lifetime income as well as income in a particular year Progressivity of tax system as a whole more important than progressivity of any particular tax Importance of nonmonetary income

Progressivity of Tax System Tax system is slightly progressive overall Most progressive tax is income tax Sales and excise taxes generally regressive Property tax exhibits U-shaped pattern with respect to income

Progressivity of Tax System Problems with considering progressivity of tax system over a lifetime: People do not have lifetime income available to pay tax at any one point in time Tax structure can change substantially over time Does not consider how tax money is spent

Political Influences on Tax System Tax policy made through political process Economic analysis: Provides arguments both sides use Estimates effects of tax changes Special interests tend to dominate political debate

Tax Reform Most changes in tax law small and affect few taxpayers Many changes in the form of loopholes Allow some taxpayers to reduce tax payments 1986 tax reform

Comprehensive Versus Piecemeal Tax Reform Benefit special interests Tax code becomes more complex Comprehensive tax reform More efficient tax code Lower overall tax rates

Revenue-Neutral Tax Reform Change tax system in some ways Leave amount of tax revenues to be collected unchanged Allows efficiency and equity issues to be considered separately from amount of tax revenues

Taxes in Isolation and the Tax System Optimal provision of one tax depend on other taxes Taxes must be viewed as individual components of overall tax system