1. Chs.17 and 18 Personal Income Tax and Behavior

3. Impact of Exemptions and Deductions on the Tax Base

4. Tax Expenditures What are tax expenditures? Annual tax expenditure budget Technical problems with measuring tax expenditures –Incentive effects –Defining income –Philosophical objections

6. Taxes and Inflation Tax Indexing How inflation can affect taxes –Bracket creep –Deductions and exemptions set in nominal terms –Taxation of nominal capital gains –Taxation of nominal interestTaxation of nominal interest

7. Coping with the Tax/Inflation Problem Ad hoc reductions in tax rates Indexing of parts of tax code [1981] Should indexing be maintained? –No – ad hoc adjustments force legislature to reexamine the entire tax code –Yes – desirable to have a stable and predictable tax code and fewer opportunities for legislative mischief; repeal would have a larger impact on low-income families

8. The Alternative Minimum Tax Brief history of the AMT Computing the tax base under AMT –Add AMT tax preferences to regular taxable income –Subtract AMT exemption –Alternative minimum tax income (AMTI) Computing Tentative AMT –Apply AMT tax rate schedule to AMTI Taxpayer pays higher of tentative AMT or regular income tax liability

9. AMT as a Mass Tax Why has AMT become more important? –AMT not adjusted for inflation –Cuts in regular tax Problems with AMT –Fairness –Efficiency –Simplicity

10. Choice of Unit and the Marriage Tax Three principles –The income tax should embody increasing marginal tax rates –Families with equal income should, other things being the same, pay equal taxes –Two individuals’ tax burdens should not change when they marry; the tax system should be marriage neutral No tax system can adhere to all three simultaneously

11. Tax Liabilities Under a Hypothetical System Individual Income Individual Tax Family Tax with Individual Filing Joint Income Joint Tax Lucy$1,000$ 100 $ 12,200 $ 30,000 $ 12,600 Ricky29,00012,100 Ethel15,0005,100 10,20030,00012,600 Fred15,0005,100

12. Brief History of Marriage Tax in the United States Pre-1948 taxable unit was individual 1948 family became taxable unit –Income splitting 1969 New tax rate schedule for unmarried people created 1981 New deduction for two-earner married couples added 1986 Two-earner deduction eliminated 2001 law reduces (but does not eliminate) marriage penalty”

13. Analyzing the Marriage Tax Advantages to using the family as taxable unit –Fairer treatment of nonlabor income (bedchamber transfers of property) –Family a bedrock institution of society Disadvantages of using the family as taxable unit –Given high divorce rates, bedchamber transfers of property may not be significant –Defining the family Efficiency issues –Does tax system affect marriage and divorce rates? –Labor supply

14. Capital Gains P = $100,000 g = 10% $100,000*(1+.1)^20 = $672,750 Capital Gain = $672,750 - $100,000 = $572,750 Tax $572,750 *.2 = 114,550 Net Gain = $458,200 P = $100,000 g = 10%net g = 10%(1-.2) = 8% $100,000*(1+.08)^20 = $466,096 Capital Gain = $466,096 - $100,000 = $366,096 Taxes deferred are taxes saved Lock-in Effect Gains Not Realized at Death

15. Evaluation of Capital Gains Rules No justification under optimal tax literature for preferential treatment of capital gains under H-S criterion Other justifications –Capital gains are unexpected windfalls –Require sacrifice of abstaining from consumption –Needed to stimulate capital accumulation and risk taking –Counterbalance to effect of inflation

16. Politics and Tax Reform Disagreements among experts Any change will hurt someone Tax system with low rates and broad base is not stable politically -political patronage Ch. 21 discusses fundamental changes to tax system

17. Personal tax and behavior

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20. Effects of Taxation Hours of leisure per week Income per week 0T D F G ii iii E1E1 i J E3E3 H K Hours of work before tax Hours of work after taxHours of work after tax

21. Labor Supply Response: Empirical Evidence Small inelastic response for men-.05 Married women are more responsive-.4

22. Impact of taxes on savings

39. Empirical Evidence: Tax on Savings Expected real rate of return difficult to measure Bernheim(2002)—very little effect of after-tax ROR –Income and substitution effect tend to cancel each other Tax expenditures for savings: 1975: $20b 2006: $105b