Chapter 6, Section 3 Fairness in Taxes Part 1: Fairness & Tax Structures Part 2: Calculating Taxes Part 3: What is a Fair Tax Policy? Mr. Vasu – Honors

Chapter 6, Section 3

Fairness in TaxesFairness in Taxes

Part 1: Fairness & Tax StructuresPart 1: Fairness & Tax StructuresPart 2: Calculating TaxesPart 2: Calculating TaxesPart 3: What is a Fair Tax Policy?Part 3: What is a Fair Tax Policy?

Mr. Vasu – Mr. Vasu – Honors Honors EconomicsEconomics


Fairness in Taxes: ObjectivesFairness in Taxes: Objectives1.1. Identify Identify different taxes levied by the governmentdifferent taxes levied by the government

2.2. Determine Determine the fairness of taxes using ability-to-pay the fairness of taxes using ability-to-pay and benefits receivedand benefits received

3.3. Define Define progressive, regressive and proportional tax progressive, regressive and proportional tax structuresstructures

4.4. Analyze Analyze the fairness of different tax structures on the fairness of different tax structures on different familiesdifferent families


Why do we need Taxes?Why do we need Taxes?

1.1. Government has expenses:Government has expenses:

1.1. Provide public goods/market failures Provide public goods/market failures

2.2. Wealth redistribution programsWealth redistribution programs

3.3. Promote employment, growth and stabilityPromote employment, growth and stability

2.2. Government needs revenue to pay for Government needs revenue to pay for expensesexpenses

• Government Government levieslevies taxes (collects) taxes (collects)


Fairness in Taxes: 2 PerspectivesFairness in Taxes: 2 PerspectivesFairness in taxes is defined by two opposing perspectives:Fairness in taxes is defined by two opposing perspectives:• Ability to payAbility to pay

• You pay taxes based on what you can affordYou pay taxes based on what you can afford• Wealthier people should pay higher tax ratesWealthier people should pay higher tax rates• Income Tax, Estate TaxIncome Tax, Estate Tax• Used to fund public goods/non-rival goods everyone Used to fund public goods/non-rival goods everyone

usesuses•Benefits receivedBenefits received

• People who use goods/services should pay the taxesPeople who use goods/services should pay the taxes• Used to fund government-funded G&S not used by allUsed to fund government-funded G&S not used by all• Toll road; National Park fees; Parcs&Rec Gym feesToll road; National Park fees; Parcs&Rec Gym fees• Sales Tax, Excise Tax (gas/tobacco/alcohol) Sales Tax, Excise Tax (gas/tobacco/alcohol)

Property Tax, Capital Gains Tax & FICA TaxProperty Tax, Capital Gains Tax & FICA Tax


1.1. Is it easy to figure out who is using a government Is it easy to figure out who is using a government good or service?good or service?

1.1. Yes – Whoever receives benefit should pay taxYes – Whoever receives benefit should pay tax

2.2. No – Whoever has ability to pay should pay taxNo – Whoever has ability to pay should pay tax

• Should wealthier people pay the burden of the tax?Should wealthier people pay the burden of the tax?• Yes – Whoever has ability to pay should pay taxYes – Whoever has ability to pay should pay tax• No – Whoever receives benefit should pay taxNo – Whoever receives benefit should pay tax

Fairness in Taxes: 2 PerspectivesFairness in Taxes: 2 PerspectivesIn deciding who pays and whether it is fair, answer In deciding who pays and whether it is fair, answer these two questionsthese two questions


Mr. Vasu rides his bike to work. Ms. Ostanski Mr. Vasu rides his bike to work. Ms. Ostanski drives her car to work. drives her car to work. Justify how this tax is fair for the taxpayers?Justify how this tax is fair for the taxpayers?

• They both pay income tax, since they have middle-class They both pay income tax, since they have middle-class jobs, which is used to fund the roads and other public jobs, which is used to fund the roads and other public goods in Chicagogoods in Chicago

• Ms. Ostanski pays a gas tax (used to fund clean energy Ms. Ostanski pays a gas tax (used to fund clean energy and public transit) whenever she fills up her car. Mr. and public transit) whenever she fills up her car. Mr. Vasu does not pay this tax.Vasu does not pay this tax.

• Mr. Vasu pays an annual fee to use the city parks gyms, Mr. Vasu pays an annual fee to use the city parks gyms, like Welles and Margate Parklike Welles and Margate Park

Fairness in Taxes: Check 4 UnderstandingFairness in Taxes: Check 4 Understanding

Ability-to-Pay: Public goods are shared by all. They can afford the tax

Benefits Received Ms. O is using the gas, so she should pay tax for it.

Benefits Received Mr. Vasu is using the gym, so he should pay for it.


Tax Structures and BasesTax Structures and Bases1.1. The tax structure determines how equally the The tax structure determines how equally the

tax is paid by taxpayerstax is paid by taxpayers

2.2. There are three major tax structures:There are three major tax structures:

• Progressive TaxesProgressive Taxes

• Regressive TaxesRegressive Taxes

• Proportional TaxesProportional Taxes

3.3. A tax structure is applied to a tax base:A tax structure is applied to a tax base:

• income, wealth, property, goods/servicesincome, wealth, property, goods/services


Progressive Tax Progressive Tax • Tax rate increases as income increasesTax rate increases as income increases• Example: Federal Income taxExample: Federal Income tax• Ability to pay fairness: wealthier people pay Ability to pay fairness: wealthier people pay

both higher tax rates and tax amountsboth higher tax rates and tax amounts


Regressive Tax Regressive Tax • Tax rate decreases as income increases (affects poorer more)Tax rate decreases as income increases (affects poorer more)• Opposite effect of progressive taxOpposite effect of progressive tax• Tax on goods/services that are a major portion of low-income Tax on goods/services that are a major portion of low-income

people’s budgetspeople’s budgets• Examples: Sales Tax, Gas tax, Sin tax, FICA taxExamples: Sales Tax, Gas tax, Sin tax, FICA tax• BeBenefits received fairness – if you use it, you pay tax for itnefits received fairness – if you use it, you pay tax for it

ItemItem AmountAmount % of % of IncomeIncome

RentRent $600$600 35%35%

GasGas $400$400 24%24%

FoodFood $400$400 24%24%

Consumer A (Mo. Inc. $1,700; 100gal Gas)

ItemItem AmountAmount % of % of IncomeIncome

RentRent $1000$1000 25%25%

GasGas $400$400 10%10%

FoodFood $600$600 15%15%

Consumer B (Mon. Inc. $4,000; 100gal Gas)


Proportional TaxProportional Tax• Tax rate is the same for everyoneTax rate is the same for everyone• Tax revenue will vary depending on the tax baseTax revenue will vary depending on the tax base• Examples: Capital Gains tax, Illinois State Income tax, Examples: Capital Gains tax, Illinois State Income tax, • Simple and easy to understandSimple and easy to understand

Bi-Weekly Bi-Weekly

Income EarnedIncome Earned$50$50

Payroll Tax RatePayroll Tax Rate 4%4%

Payroll Tax AmountPayroll Tax Amount $2$2

Employee A Employee B

Bi-Weekly Income Bi-Weekly Income EarnedEarned

$3,000$3,000

Payroll Tax RatePayroll Tax Rate 4%4%

Payroll Tax AmountPayroll Tax Amount $120$120


Tax Structures: Check 4 UnderstandingTax Structures: Check 4 Understanding1.1. The income tax rate that people pay increases as The income tax rate that people pay increases as

people make more money. Income tax rate is 10% if a people make more money. Income tax rate is 10% if a single person makes less than $8,500 per year, while single person makes less than $8,500 per year, while it is 25% for someone who earns $50,000. it is 25% for someone who earns $50,000. Is this tax Is this tax structure progressive, regressive or proportional? structure progressive, regressive or proportional? Why? Why?

2.2. The government is considering levying a tax on low-The government is considering levying a tax on low-cost, but unhealthy food items like chips, soda and cost, but unhealthy food items like chips, soda and fast food,fast food,

1.1. Would this tax be progressive, regressive or proportional? Would this tax be progressive, regressive or proportional? Why? Why?

2.2. Is the tax still fair/justified? Why/Why not?Is the tax still fair/justified? Why/Why not?


Calculating Income TaxesCalculating Income Taxes• Federal Income Tax is a Progressive TaxFederal Income Tax is a Progressive Tax

• Tax rate increases as income increasesTax rate increases as income increases

• The The tax structuretax structure is provided by the Federal Income is provided by the Federal Income Tax Brackets and Marginal Tax RatesTax Brackets and Marginal Tax Rates

• Marginal tax rates only apply to a specific marginal tax baseMarginal tax rates only apply to a specific marginal tax base

• To calculate individual federal income tax, you will To calculate individual federal income tax, you will need the need the tax basetax base

• Tax base: income in one year (from W2 forms)Tax base: income in one year (from W2 forms)

• Total tax amountTotal tax amount is the sum of the marginal tax is the sum of the marginal tax amountsamounts

• Multiply the marginal tax rate by the tax bracket amountMultiply the marginal tax rate by the tax bracket amount


Calculating Income TaxesCalculating Income Taxes• The marginal tax rate is only applied to each The marginal tax rate is only applied to each

marginal tax basemarginal tax base

• Overall tax rate = Overall tax rate = total tax amount total tax amount

annual incomeannual income


Calculating Income TaxesCalculating Income Taxes

Marginal Tax Rate (Progressive)

Single Filing Status: Tax Base: Annual Income

Single Filing Status: Marginal Tax Rate Calculation

35% Over $388,350

$112,683.50 plus 35% of the excess over $388,350

33% Over $178,650 but not over $388,350


28% Over $85,650 but not over $178,650


25% Over $35,350 but not over $85,650


15% Over $8,700 but not over $35,350 $870 plus 15% of the excess over $8,700 10% Not over $8,700 10% of the taxable income


Calculating Income Taxes: Tax TowerCalculating Income Taxes: Tax Tower

10%

$0

Marginal

Tax rateMarginal Tax Base

Marginal Tax Amount

$8,700

$35,530

$85,650

$95,000

$8,700

$26,830

$50,120

$8,350

15%

25%

28%

Tax Rate * Tax Base =

$870

$4,024.50

$12,530

$2,338

Total Tax Amount

$17,424.50

28% of $8,350 = $2,338

$17,424.50

+ 2,338

Total Tax Amount $19,762.50

19,762.50/95,000

Overall Tax Rate 20.8%

Single Filer with Annual Income of $95,000 in 2012

This is given in Tax Brackets


Calculating Income TaxesCalculating Income Taxes• What is the overall tax amount for someone What is the overall tax amount for someone filing as singlefiling as single who who

earns $60,000 per year?earns $60,000 per year?• What is the overall tax rate?What is the overall tax rate?

10%

$8,700

$35,530

15%

25%

$870

$4,024.50 $4,867.50

Marginal

Tax rateMarginal Tax Base

Marginal Tax Amount

$60,000

Total Tax Amount

$8,700

$26,830

$24,470 $6,117.50 25% of $24,470 = $6,117.50

Total Tax Amount $10,985

10,985/60,000

Overall Tax Rate 18.3%

This is given in Tax Brackets


Tax Expenditures: Tax Expenditures: Gross vs. Taxable IncomeGross vs. Taxable Income• So far, we assumed the taxpayers would pay tax on So far, we assumed the taxpayers would pay tax on

all the income earned in one year (all the income earned in one year (gross income)gross income)

• Taxpayers only pay tax on their Taxpayers only pay tax on their taxable incometaxable income

• The government allows taxpayers to lower or reduce the The government allows taxpayers to lower or reduce the amount of income they owe tax onamount of income they owe tax on

• These are tax expenditures (they reduce government These are tax expenditures (they reduce government revenues)revenues)

• Deductions and Exemptions lower taxable incomeDeductions and Exemptions lower taxable income

• Taxable income is less than gross incomeTaxable income is less than gross income


Tax Expenditures: DeductionsTax Expenditures: Deductions• Subtracted from gross incomeSubtracted from gross income

• Taxpayers can choose either the standard deduction Taxpayers can choose either the standard deduction or to itemize individual deductions or to itemize individual deductions

• Standard deduction is $5,950 for single and $11,900 Standard deduction is $5,950 for single and $11,900 for joint filers in 2012for joint filers in 2012

• Choose itemize if individual deductions will be Choose itemize if individual deductions will be greater than the standard deductiongreater than the standard deduction

• Common itemized deductions include: mortgage Common itemized deductions include: mortgage payments, property tax, uninsured medical payments, property tax, uninsured medical expenses, charitable contributionsexpenses, charitable contributions


• ExemptionsExemptions

• Subtracted from gross incomeSubtracted from gross income

• Everyone qualifies for a $3,800 exemptionEveryone qualifies for a $3,800 exemption

• CreditsCredits

• Subtracted directly from taxes owedSubtracted directly from taxes owed

• Common credits include for education Common credits include for education expenses and incentivesexpenses and incentives

Tax Expenditures: Exemptions and CreditsTax Expenditures: Exemptions and Credits


Income vs. Capital Gains TaxIncome vs. Capital Gains Tax• Marginal income tax rates are higher than capital Marginal income tax rates are higher than capital

gains tax for most individualsgains tax for most individuals

• Capital Gains tax is only 15%Capital Gains tax is only 15%

• Many high-income individuals’ annual earnings Many high-income individuals’ annual earnings comes in the comes in the form of capital gainsform of capital gains and not income and not income

• They generate income from savings/investments much more than They generate income from savings/investments much more than lower-income individualslower-income individuals

• Stock options, dividends, equity payouts, interest earningsStock options, dividends, equity payouts, interest earnings

• Income taxes are not as progressive when the Income taxes are not as progressive when the wealthiest people don’t pay income tax!wealthiest people don’t pay income tax!


Key TermsKey Terms Ability to payAbility to pay:: People with different amounts of People with different amounts of

wealth or income should pay tax at different rateswealth or income should pay tax at different rates Benefits receivedBenefits received:: People should pay taxes People should pay taxes

based on the benefits they receive from based on the benefits they receive from government goods and services government goods and services

Progressive taxProgressive tax:: Tax for which the percentage of Tax for which the percentage of income paid in taxes increases as income income paid in taxes increases as income increasesincreases

Proportional taxProportional tax:: A tax for which the percentage A tax for which the percentage of income paid in taxes remains the same at all of income paid in taxes remains the same at all income levelsincome levels


Key TermsKey Terms Regressive taxRegressive tax:: A tax for which the percentage A tax for which the percentage

of income paid in taxes decreases as income of income paid in taxes decreases as income increasesincreases

Tax baseTax base:: the income, wealth, property, good the income, wealth, property, good or service that is being taxed or service that is being taxed

Income taxIncome tax:: Tax on income, or revenue earned Tax on income, or revenue earned from wages; individuals and companies pay from wages; individuals and companies pay income taxincome tax

Tax bracketTax bracket:: Based on income level, the Based on income level, the category of income tax an individual qualifies category of income tax an individual qualifies forfor

Marginal Tax RateMarginal Tax Rate:: the tax rate at the highest the tax rate at the highest tax bracket an individual’s income qualifies fortax bracket an individual’s income qualifies for


Key TermsKey Terms Capital Gains taxCapital Gains tax:: Tax on wealth, such as interest, Tax on wealth, such as interest,

dividends and gains on stock and other asset sales; dividends and gains on stock and other asset sales; levied mostly on high income peoplelevied mostly on high income people

Property taxProperty tax:: A tax based on real estate and other A tax based on real estate and other propertyproperty

Sales taxSales tax:: Tax on goods or services that are sold Tax on goods or services that are sold

Excise/Sin taxExcise/Sin tax:: high sales tax rates on tobacco, high sales tax rates on tobacco, alcohol and gambling; levied disproportionately on alcohol and gambling; levied disproportionately on low income peoplelow income people

FICA taxFICA tax:: Tax that all US workers must pay to fund Tax that all US workers must pay to fund Social Security/Medicare and other retirement Social Security/Medicare and other retirement benefits programs. Benefits received tax. Regressive benefits programs. Benefits received tax. Regressive tax since it is not paid on income earned over $100k. tax since it is not paid on income earned over $100k.

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Chapter 6, Section 3 Fairness in Taxes Part 1: Fairness & Tax Structures Part 2: Calculating Taxes Part 3: What is a Fair Tax Policy? Mr. Vasu – Honors