1. Taxes: Equity versus Efficiency
Chapter 32
McGraw-Hill/Irwin
Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved.

2. The Size Distribution of Income
Size distribution of income: The way total personal income is divided up among households or income classes
Income share: The proportion of total income received by a particular group

3. Cumulative Percentage Cumulative Percentage of People
The Lorenz Curve 10 20 30 40 50 60 70 80 90
100
Inequality gap
Absolute equality
Cumulative Percentage
of Income
Actual distribution B C
27.5 A
3.6
Cumulative Percentage of People

4. The Federal Income Tax Federal income tax is meant to be progressive
Progressive tax: A tax system in which tax rates rise as incomes rise
This is achieved by imposing increasing marginal tax rates on higher incomes
Marginal tax rate: The tax rate imposed on the last (marginal) dollar of income

5. Loopholes
People with high incomes can avoid high taxes by claiming large exemptions and deductions
These may violate the following principles of
Vertical equity: Principle that people with higher incomes should pay more taxes
Horizontal equity: Principle that people with equal incomes should pay equal taxes

6. Nominal vs. Effective Tax Rates
The gap between the nominal tax rate and the effective tax rate is a reflection of loopholes in the tax code

7. Tax-Induced Misallocations
Tax loopholes not only foster inequity but encourage inefficiency
Tax preferences induce resource shifts into tax-preferred activities
Some feel the federal income tax promotes both inequity and inefficiency

8. Payroll, State, and Local Taxes
The federal income tax is only one of many taxes the average taxpayer must pay
Sales taxes and property taxes are both regressive
Regressive tax: A tax system in which tax rates fall as incomes rise

9. Tax Incidence Tax incidence: Distribution of the real burden of a tax
The burden of property taxes is reflected in higher rents
Landlords tend to pass along property taxes
Tenants pay higher rents because of this

10. Incidence of a Payroll Tax
Quantity of Labor
Wage Rate
S + tax
Supply of labor
Payroll taxes reduce wages and employment w1 w0 w2
Demand for labor L1 L0

11. The Impact of Transfers
The government completes the redistribution process by transferring income to consumers
Income transfers: Payments to individuals for which no current goods or services are exchanged, for example, Social Security, welfare, and unemployment benefits

12. The Costs of Greater Equality
The greatest potential cost of moving toward greater income equality is reduced incentives
Absolute income equality breaks the market link between effort and reward
The argument for preserving income inequalities is anchored in a concern for productivity

13. The Benefits of Greater Equality
Arguments for greater equality include:
The present degree of inequality is more than necessary to maintain work incentives
Low-income earners might work harder if incomes were distributed more fairly
Resources might be allocated more efficiently if greater equality achieved via tax simplification

14. Taxes: Equity versus Efficiency
End of Chapter 32
McGraw-Hill/Irwin
Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved.