Sources of Government Revenue

The Economics of Taxation : Economic Impact of Taxes

• Taxes/Other government revenues affect:– resource allocation, – consumer behavior, – nation’s productivity – Growth

Economic Impact of Taxes : Resource Allocation

• Affects factors of production

• A TAX placed on a good at the factory = rise in production cost

• Supply curve shifts to the left

• If demand stays the same = equilibrium price goes op

Economic Impact of Taxes: Behavior adjustment

• TAXES affect the economy – Encourage or discourage

certain activities – SIN Tax: high percentage tax

that raises revenue while reducing consumption of a socially undesirable product

Economic Impact of Taxes: Productivity and Growth

• Taxes affect productivity and economic growth:– Change incentives to save,

invest, and work

• Why people favor lower taxes….

Economic Impact of Taxes: The Incidence of a Tax

• “Final Burden of the Tax”• I.e. Utility company:

– Raise rates: consumer bears the burden

• (easy if demand is inelastic)

– Rates are regulated = • Shareholders receive smaller

dividends; postpone raises• (more elastic = producer will

absorb the tax)

Criteria for Effective Taxes

• TAXES are effective when they are:– Equitable– Simple – Efficient

Criteria for Effective Taxes

• Criterion 1: Equity or fairness – Taxes should be

IMPARTIAL and JUST– Fairness is subjective– Taxes are considered

FAIRER – Fewer loopholes:

exceptions, deductions, and exemptions

• Criterion 2: Simplicity – Tax LAWS should be EASY to

understand – Individual income taxes: the

taxes on peoples earnings • Complex tax = dislike

– Sales tax: general tax levied on most consumer purchases;

• paid at the time of purchase • Anyone purchases = pay tax

Criteria for Effective Taxes

• Criterion 3: Efficiency – Easy to administer and

successful at generating revenue

– Individual income tax – Less efficient: toll booths – Luxury taxes

Criteria for Effective Taxes

Two Principles of Taxation

• Benefit Principle: those who benefit from government and services should pay in proportion to the amount of benefits received – Gas tax (built in) pay more if you

drive more

• Two limitations:– Many gov’t services provide the

greatest benefits to those who can least afford to pay for them

– Benefits are hard to measure

• Ability-to-Pay Principle: people should be taxed according to their ability to pay, regardless of the benefits they receive.

• Two factors– Recognizes that societies cannot

always measure benefits – Assumes that people with higher

incomes suffer less discomfort paying taxes than people with lower income

Two Principles of Taxation

Types of Taxes

• Proportional: imposes same percentage rate of taxation on everyone

• Progressive: imposes a higher percentage rate of taxation on people with high incomes than on those with low incomes

• Regressive: imposes a higher percentage rate of taxation on low incomes than on high incomes

Figure 9.3

The Federal Tax System

IRS (Internal Revenue

Service)

part of the Treasury Department

Individual Income Taxes

• Fed. Gov’t collects 45% of its revenue from Individual income taxes

• Paid over time through payroll withholding system

• Before April 15th each year, an employee must file a tax return: an annual report to the IRS summarizing total income, deductions, & taxes withheld by employers

• Progressive tax– Individuals earning higher

incomes pay higher tax rates

• Progressive Tax that ranges from 15% -39.6%

Individual Income Taxes

FICA: What is FICA? And why does it take part of my

paycheck

• FICA stands for Federal Insurance Contributions Act

• FICA tax includes Social Security (6.2% of wages) & Medicare (1.45% of wages)

• 2nd largest source of Gov’t revenue

FICA

• Social Security is a proportional tax up to $65,400 (the capping point) and then it is regressive

• Medicare is not capped; it’s proportional at all levels of income

• Total FICA tax = 7.65%

Corporate Income Taxes

• 3rd largest category of federal taxes

• Corporation is recognized as a separate entity

• Rates vary from 15% -35% (slightly progressive)

Other Federal Taxes

• Excise Tax: tax on the manufacture or sale of certain items, such as gasoline and liquor

• Estate Tax: tax the gov’t levies on the transfer of property when a person dies

• Gift Tax: tax on gift of money/wealth paid by person making gift

State and Local Tax Systems

State Government Revenue Sources

• Intergovernmental Revenues - money from federal gov’t

• Sales tax - general tax on consumer purchases

• Employee Retirement Contributions

• Individual Income Taxes (not all states)

States with the Highest Sales Tax:

• Mississippi• Rhode Island• Washington• Texas• Illinois

STATE SALES TAX

• States Without a State Sales Tax:

• Alaska• Delaware• Montana• New Hampshire• Oregon

STATE SALES TAX

• Effective way to raise large sums of money

• Difficult to avoid because it affects large numbers of consumers

• Relatively easy to administer - merchant collects at point of sale

Advantages of Sales Tax

• Second largest source of revenue for local governments

• Real Property: includes real estate, buildings, & anything permanently attached

Local Property Taxes

• Tangible Personal Property: includes tangible items, not permanently attached.

• Intangible Personal Property: property with invisible value, such as stock, bond, patent, check

Local Property Taxes

Examining Your Paycheck

• Payroll withholding statement: the summary statement attached to a paycheck that summaries income, tax withholdings, and other deductions

• State & local governments rely heavily on sales tax for revenues

• State & local governments already lose $3.3 billion each year to untaxed interstate sales

• This figure will increase as more sales are made over the Internet

• Should there be an Internet sales tax??? How would it work?

QUESTION: WHY ARE STATE & LOCAL

GOVERNMENTS LOSING MONEY TO THE INTERNET???