TAXES: The Main Source of Government RevenueEconomics for the 21st Century

Two Views from the Top

Taxes, after all, are dues that we pay for the Taxes, after all, are dues that we pay for the privileges of membership in an organized privileges of membership in an organized society.  ~Franklin D. Rooseveltsociety.  ~Franklin D. Roosevelt

The government’s view of the economy could be The government’s view of the economy could be summed up in a few short phrases:  If it moves, summed up in a few short phrases:  If it moves, tax it.  If it keeps moving, regulate it.  And if it tax it.  If it keeps moving, regulate it.  And if it stops moving, subsidize it.  ~Ronald Reaganstops moving, subsidize it.  ~Ronald Reagan

DefinitionsTax: A contribution for the support of Tax: A contribution for the support of a government required of persons, a government required of persons, groups, or businesses within the groups, or businesses within the domain of that governmentdomain of that government

DefinitionsMarginal Tax Rate: Amount of tax Marginal Tax Rate: Amount of tax paid on the last dollar earned paid on the last dollar earned

Average Tax Rate: Total tax paid as Average Tax Rate: Total tax paid as a percentage of total income a percentage of total income earnedearned

Four Principle Objectives of Taxation

• Raise revenueRaise revenue• Address externalitiesAddress externalities• Re-pricingRe-pricing• RepresentationRepresentation

Incidence of a TaxWho bears the final burden of this tax?Who bears the final burden of this tax?•If there is a relatively If there is a relatively inelastic demand inelastic demand curve the burden can be shifted to the curve the burden can be shifted to the consumerconsumer..•If there is a relatively If there is a relatively elastic demand elastic demand curve, thecurve, the producerproducer will absorb the tax.will absorb the tax.

To be effective, taxes must meet the following criteria:

• EquityEquity

• SimplicitySimplicity

• EfficiencyEfficiency

TWO PRINCIPLES of TAXATION(There are Others!)

““Who pays What” is based Who pays What” is based on two principles:on two principles:

•Benefit Benefit Principle Principle •Ability to Pay Ability to Pay

Types of Taxes

Taxes are classified according to the Taxes are classified according to the way in which the tax burden changes way in which the tax burden changes as income changes.as income changes.•ProportionalProportional TaxTax•Progressive Progressive TaxTax•RegressiveRegressive Tax Tax

Proportional Taxes• Regardless of Income, the same tax rate is

imposed upon everyone. Another term for a proportional tax is a flat tax.

• If there is a 20% flat tax, how much do you pay in taxes if you earn $10,000? What if you earn $100,000?

• Note as a person’s income increases, the percentage of total income paid in taxes remains the same.

• Property Tax is a proportional tax.

Proportional Tax

Income

10,000 50,000 100,000

Tax Rate

40%

20%

10%

Progressive Tax

• People with higher incomes pay a higher People with higher incomes pay a higher percentage percentage in taxes. Federal and in taxes. Federal and State income tax are progressive taxes.State income tax are progressive taxes.

INCOMEINCOME Amount Amount Paid in Paid in TaxesTaxes

Amount Amount Paid as a Paid as a percentagpercentage of e of IncomeIncome

$10,000$10,000 $1,000$1,000 10%10%

$50,000$50,000 $ 10,000$ 10,000 20%20%

$100,000$100,000 $ 30,000$ 30,000 30%30%

Progressive Tax

Income

10,000 50,000 100,000

Tax Rate

40%

20%

10%

Regressive Taxes• The lower the income, the higher the The lower the income, the higher the

percentage paid percentage paid in taxes. in taxes. • Sales tax is an example of a regressive tax. Sales tax is an example of a regressive tax.

Assume two families paid $1000 in sales tax Assume two families paid $1000 in sales tax by the end of the year. Which family spent by the end of the year. Which family spent a higher percent of their income on taxes?a higher percent of their income on taxes?

Income Amount paid in taxes

Amount paid in taxes as a percentage of their income.

$10,000 $1000.00 10%

$50,000 $1000.00 5%

Regressive Tax

Income

10,000 50,000 100,000

Tax Rate

40%

20%

10%

FEDERAL TAXESAmendment XVI Amendment XVI gives Congress gives Congress the power to lay the power to lay and collect taxes and collect taxes on individual on individual incomes. incomes.

Income Tax

• The psychological game of The psychological game of withholding withholding

• From an economist’s point of From an economist’s point of view, is it better to owe money view, is it better to owe money to the IRS or receive a refund to the IRS or receive a refund check? WHY?check? WHY?

More Federal Taxes• FICA - Federal Insurance Contributions ActFICA - Federal Insurance Contributions Act

– Social Security and MedicareSocial Security and Medicare• Corporate Income Tax - As a separate Corporate Income Tax - As a separate

legal entity, corporations are taxed.legal entity, corporations are taxed.• Excise Tax - tax on the manufacture or sale Excise Tax - tax on the manufacture or sale

of selected itemsof selected items• Estate Tax - tax on the transfer of property Estate Tax - tax on the transfer of property

upon a death. Repealed for 2010, but upon a death. Repealed for 2010, but scheduled for 55% in 2011 – exempt up to scheduled for 55% in 2011 – exempt up to $1,000,000.$1,000,000.

• Gift Tax - Tax on money donations, paid by Gift Tax - Tax on money donations, paid by the person donating.the person donating.

• Customs Duties: Tax on imported goods. Customs Duties: Tax on imported goods. Exported goods may not be taxed.Exported goods may not be taxed.

State Taxes and Local Taxes

• Intergovernmental Intergovernmental Revenues - transfer Revenues - transfer of money from the of money from the federal federal governmentgovernment

• Sales TaxSales Tax• Employee Employee

Retirement Retirement ContributionsContributions

• Individual Income Individual Income TaxTax

• Intergovernmental Intergovernmental Revenues -from Revenues -from state levelstate level

• Property TaxProperty Tax• Public Utility or Public Utility or

State owned liquor State owned liquor storesstores

• Sales Tax - this Sales Tax - this varies from city to varies from city to citycity

Tax Freedom Day!

When was national tax When was national tax Freedom Day in 2012?Freedom Day in 2012?

Ohio Tax Freedom Day?Ohio Tax Freedom Day?

Why the difference?Why the difference?

Tax Freedom Day, Adjusted for the Budget Deficit

• I like to pay taxes.  With them I buy I like to pay taxes.  With them I buy civilization.  ~Oliver Wendell civilization.  ~Oliver Wendell Holmes, Jr.Holmes, Jr.

• A fine is a tax for doing something A fine is a tax for doing something wrong.  A tax is a fine for doing wrong.  A tax is a fine for doing something right.  Author Unknownsomething right.  Author Unknown