chs.17 and 18 personal income tax and behavior
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Chs.17 and 18 Personal Income Tax and Behavior. Impact of Exemptions and Deductions on the Tax Base. Tax Expenditures. What are tax expenditures? Annual tax expenditure budget Technical problems with measuring tax expenditures Incentive effects Defining income Philosophical objections. - PowerPoint PPT PresentationTRANSCRIPT
Chs.17 and 18Personal Income Tax and
Behavior
Impact of Exemptions and Deductions on the Tax Base
Impact of Subtractions from AGI on the Tax Base, 2004
32%
68%
Subtractions from AGI Taxable Income
Tax Expenditures
• What are tax expenditures?
• Annual tax expenditure budget
• Technical problems with measuring tax expenditures– Incentive effects– Defining income– Philosophical objections
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 interest
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
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
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
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
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 $12,600Ricky 29,000 12,100
Ethel 15,000 5,100
10,200 30,000 12,600Fred 15,000 5,100
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”
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
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
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
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
Personal tax and behavior
1260
Effects of Taxation
Hours of leisure per week
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Hours of work before tax
Hours of work after tax
Labor Supply Response:Empirical Evidence
• Small inelastic response for men- .05
• Married women are more responsive- .4
Impact of taxes on savings
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