PrinciplesofEconomics-lecnotes(12)

PowerPoint Lecture Notes for Chapter 12The Design of the Tax System Principles of Economics 7th edition, by N. Gregory Mankiw? 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.E conomicsPrinciples of N. Gregory Mankiw The Design of the Tax System Seventh EditionCHAPTER 12W o c e c h Ge s o n 18311901In earlier chapters, students learned some important lessons about taxes, including: the effects of a tax on the allocation of resources, tax incidence, and the deadweight loss of a tax.In this chapter, students will learn about topical policy issues suchas:?the “marriage penalty ”?the flat tax?income vs. consumption tax?the corporate income taxStudents will also learn the difference between progressive andregressive taxes, marginal and average tax rates, and variouscriteria for evaluating tax systems.The chapter begins with a financial overview of the U.S.government. Since the topic here is taxation, this PowerPointpresentation focuses on the revenue side. For additionalinformation on the spending side of the government budget,please refer to the textbook.In this chapter,look for the answers to these questions?What are the largest sources of tax revenuein the U.S.??What are the efficiency costs of taxes??How can we evaluate the equity of a tax system?? 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use aspermitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.? 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.2IntroductionOne of the Ten Principles from Chapter 1:A government can sometimesimprove market outcomes.Providing public goodsRegulating the use of common resourcesRemedying the effects of externalities To perform its many functions,the govt raises revenue through taxation.? 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.3IntroductionLessons about taxes from earlier chapters:A tax on a good reduces the market quantityof that good.The burden of a tax is shared between buyersand sellers depending on the price elasticitiesof demand and supply.A tax causes a deadweight loss.? 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.4A Look at Taxation in the U.S.First, we consider:how tax revenue as a share of national income has changed over time.how U.S. tax revenues compare to other countries.the most important revenue sources for federal,state, & local govt.0%5%10%15%20%25%30%35%192519301935194019451950195519601965197019751980198519901995200020052010%of G D P U.S. Government Receipts,1929–2011federalstate & localtotal Government receipts include: tax revenue, contributions to social insurance programs, and income from government -owned assets.From 1929 to the late 1990s, government receipts increase from10% to 30% of GDP. Note, however, that receipts as a % of GDP tend to be lower in recessions than in booms, as the graph clearly shows in 20012002 and again in 2008–2009. Since the first ten years of data inthis graph correspond to the Great Depression, we might get amore accurate sense of the long -run trend if we focus on theperiod starting after the end of the Great Depression and endingbefore the “Great Recession ” of 2008–2009. From 1940 to 200total receipts increase from 16% to 30% - still a huge increase,but less dramatic than for the period beginning in 1929.Sources: Economic Report of the President Table 15.1, HistoricalStatistics of the United States, Bureau of Economic AnalysisTotalGovernmentRevenue(% of GDP)Denmark 48%Sweden 45France 44Italy43Germany37United Kingdom36Spain32Canada31Greece31Japan28Australia26United States25Chile21Mexico 20Tax revenue (relative to GDP) varies across countries. For the countries included in this table, the U.S. is roughly in the middle. Europe is generally higher, while lower -income countries are generally lower. Source: OECD, United Nations. Data are for 2011.? 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.7Receipts of the U.S. Federal Govt, 2012:Q1Tax Amount(billions)Amountper personPercentof receiptsIndividual income taxes$ 1,123$3,58742.2% Social insurance taxes9282,96534.9 Corporate income taxes3761,20014.1 Other2357518.8 Total$2,662$8,503100.0%The individual income tax is typically the largest source of revenue for the U.S. federal government. Social insurance taxes (Social Security, Medicare, etc.) run a close second.Source: NIPA, Table 3.2, Bureau of Economic Analysis, U.S. Department of Commerce, available here:/iTable/iTable.cfm?ReqID=9&step=1Source for population: U.S. Census. I used the March 1, 2012 estimate (313,104,674) from/popest/data/national/totals/2011/index.ht mlfile: NA_EST2011-01.xlsTable 1? 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.8Receipts of State & Local Govts, 2012:Q1Tax Amount(billions)Amountper personPercentof receiptsSales taxes$476.4$1,52234.2% Property taxes446.51,42632.1 Individual income taxes293.893821.1 Corporate income taxes50.1160 3.6 Other124.43978.9 Total$1,391$4,323100.0%The most important revenue sources for state and local governments are funds from the federal government and revenue from sales and property taxes. Income taxes are also important in many states.Source: NIPA, Table 3.3, Bureau of Economic Analysis, U.S. Department of Commerce, available here:/iTable/iTable.cfm?ReqID=9&step=1Source for population: U.S. Census. I used the March 1, 2012 estimate (313,104,674) from/popest/data/national/totals/2011/index.ht mlfile: NA_EST2011-01.xlsTable 1? 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.9Taxes and EfficiencyOne tax system is more efficient than another if it raises the same amount of revenueat a smaller cost to taxpayers.The costs to taxpayers include:the tax payment itselfdeadweight lossesadministrative burden10? 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use aspermitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.Deadweight LossesOne of the Ten Principles:People respond to incentives.Recall from Chapter 8:Taxes distort incentives, cause people to allocateresources according to tax incentives rather thantrue costs and benefits.The result: a deadweight loss.The fall in taxpayers ’ well-being exceeds the revenue the govt collects. Deadweight loss was covered extensively in Chapter 8. Any students needing review should read the brief example at this point in Chapter 12, which very clearly recaps the idea of a deadweight loss from taxation in the context of a simple example.11? 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.Income vs. Consumption TaxThe income tax reduces the incentive to save:If income tax rate is 25%,8% interest rate = 6% after-tax interest rate.The lost income compounds over time.Some economists advocate taxing consumptioninstead of income.Would restore incentive to save.Better for individuals ’ retirement income securityand long-run economic growth.The material on this slide corresponds to a case study in the chapter. See the textbook for a dramatic example of the income tax disincentive to saving. 12? 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use aspermitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.Income vs. Consumption TaxConsumption tax-like provisions in the U.S. taxcode include Individual Retirement Accounts,401(k) plans.People can put a limited amount of saving intosuch accounts.The funds are not taxed until withdrawn atretirement.Europe ’s Value -Added Tax (VAT) is like aconsumption tax.13? 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use aspermitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.Administrative BurdenIncludes the time and money people spend tocomply with tax laws.Encourages the expenditure of resources onlegal tax avoidance.e.g., hiring accountants to exploit“loopholes ”　to reduce one ’s tax burdenIs a type of deadweight loss.Could be reduced if the tax code were simplifiedbut would require removing loopholes,politically difficult.? 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use aspermitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.14Marginal vs. Average Tax RatesAverage tax ratetotal taxes paid divided by total incomemeasures the sacrifice a taxpayer makesMarginal tax ratethe extra taxes paid on an additional dollar ofincomemeasures the incentive effects of taxeson work effort, saving, etc .15? 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.Marginal tax rate Average tax rate Income0%10%$40,0000%20%$20,000Lump-Sum TaxesA lump-sum tax is the same for every personExample: lump-sum tax = $4000/person16? 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use aspermitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.A lump-sum tax is the most efficient tax:Causes no deadweight lossDoes not distort incentives.Minimal administrative burdenNo need to hire accountants, keep track ofreceipts, etc.Yet, perceived as unfair:In dollar terms, the poor pay as much as the rich.Relative to income, the poor pay much more thanthe rich.Lump-Sum Taxes? 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use aspermitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.17Taxes and EquityAnother goal of tax policy:equity –distributing the burden of taxes“fairly.”Agreeing on what is“fair ” is much harder than agreeing on what is “efficient.”Yet, there are several principles people applyto evaluate the equity of a tax system.? 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use aspermitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.18The Benefits PrincipleBenefits principle : the idea that people shouldpay taxes based on the benefits they receivefrom govt servicesTries to make public goods similar to privategoods —the more you use, the more you pay.Example: Gasoline taxesAmount of tax paid is related tohow much a person uses public roads.? 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.19The Ability-To-Pay PrincipleAbility-to-pay principle : the idea that taxesshould be levied on a person according to howwell that person can shoulder the burdenSuggests that all taxpayers should make an“equal sacrifice.”Recognizes that the magnitude of the sacrificedepends not just on the tax payment, but on theperson ’s income and other circumstances.A $10,000 tax bill is a bigger sacrifice for apoor person than a rich person.20? 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use aspermitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.Vertical EquityVertical equity : the idea that taxpayers with agreater ability to pay taxes should pay largeramounts21? 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use aspermitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.Three Tax SystemsProportional tax :Taxpayers pay the same fraction of income,regardless of income.Regressive tax :High-income taxpayers pay a smaller fraction oftheir income than low-income taxpayers.Progressive tax :High-income taxpayers pay a larger fraction oftheir income than low-income taxpayers.22? 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use aspermitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.200,000100,000$50,000% of income tax % of income tax % of income tax income3060,0002525,00020%$10,000Progressive 2550,0002525,00025%$12,500Proportional 2040,0002525,00030%$15,000RegressiveExamples of the Three Tax SystemsThis slide replicates Table 7 in the textbook. Point out that even a regressive income tax satisfies vertical equity, as vertical equity only requires that the dollar amount of taxes rise with income, not the average tax rate.? 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.23U.S. Federal Income Tax Rates: 2012On taxable income …the tax rate is …0 –$8,70010%8,701 –35,35015%35,351 –85,65025%85,651 –178,65028%178,651 –388,35033%Over $388,35035%The U.S. has aprogressiveincome tax. The tax rates in this table are for single filers. Source: 2012 tax rate schedule, .Note on interpreting the table: The tax rates shown are marginal tax rates that apply only to income in the corresponding brackets. For example, a person earning $30,000 would pay 10% on the first $8,700 of income, and 15% on income above $8,700. He would not pay 15% on his ENTIRE income.As the table shows, the U.S. income tax is progressive. This tableexcludes transfer payments, which accrue mainly to lower incomepersons. Factoring in transfer payments, the system looks evenmore progressive. 24? 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.Horizontal EquityHorizontal equity : the idea that taxpayers withsimilar abilities to pay taxes should pay thesame amountProblem: Difficult to agree on what factors,besides income, determine ability to pay.A C T I VE L EA R N I N G1Taxes and marriage, part 1The income tax rate is 25%. The first $20,000 of income is excluded from taxation. Tax law treats a married couple as a single taxpayer.Sam and Diane each earn $50,000.i.If Sam and Diane are living together unmarried,what is their combined tax bill?ii.If Sam and Diane are married, what is their tax bill?? 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use aspermitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.A C T I VE L EA R N I N G1AnswersIf unmarried, Sam and Diane each pay0.25 x ($50,000 –20,000) = $7500Total taxes = $15,000 = 15% of their joint income.If married, they pay0.25 x ($100,000 –20,000) = $20,000or 20% of their joint income.The $5000 increase in the tax bill is calledthe “marriage tax” or “marriage penalty.”? 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use aspermitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.In this exercise, Sam and Diane’s problem arises because, as singles, each enjoys a $20,000 income exclusion, so the first $40,000 of theircombined income is excluded from taxes. As a married couple, onlythe first $20,000 of income is excluded.One way to fix this is to double the exclusion for married couplesrelative to single tax filers. But doing so causes another problem, as wewill see in the second part of this exerci se…A C T I VE L EA R N I N G2Taxes and marriage, part 2The income tax rate is 25%. For singles, the first $20,000 of income is excluded from taxation.For married couples, the exclusion is $40,000. Harry earns $0. Sally earns $100,000.i.If Harry and Sally are living together unmarried,what is their combined tax bill?ii.If Harry and Sally are married, what is their tax bill?? 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use aspermitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.Here, we have changed the tax code to eliminate the marriage penalty that couples like Sam and Diane face: we have doubled the exclusion for married couples.However, this creates a different kind of problem for other couples, as students will learn when they work through this exercise.A C T I VE L EA R N I N G2AnswersIf unmarried, Harry pays $0 in taxes. Sally pays0.25 x ($100,000 –20,000) = $20,000Total taxes = $20,000 = 20% of their joint income. If married, they pay0.25 x ($100,000 –40,000) = $15,000or 15% of their joint income.The $5000 decrease in the tax bill is called the “marriage subsidy.”? 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use aspermitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.29? 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use aspermitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.Marriage Taxes and SubsidiesIn current U.S. tax code,couples with similar incomes are likely to pay amarriage tax.couples with very different incomes are likely toreceive a marriage subsidy.Many have advocated reforming the tax systemto be neutral with respect to marital status …　30? 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.Marriage Taxes and SubsidiesThe ideal tax system would have these properties:Two married couples with the same total incomepay the same tax.Marital status does not affect a couple’s tax bill.A person/family with no income pays no taxes.High-income taxpayers pay a higher fraction oftheir incomes than low-income taxpayers.However, designing a tax system with all four ofthese properties is mathematically impossible. The first two of these four properties relate to horizontal equity. The last two relate to vertical equity. ? 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use aspermitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.31Tax Incidence and Tax EquityRecall: The person who bears the burden is notalways the person who gets the tax bill.Example: A tax on fur coatsMay appear to be vertically equitableBut furs are a luxury with very elastic demandThe tax shifts demand away from furs,hurting the people who produce furs(who probably are not rich)Lesson: When evaluating tax equity, must taketax incidence into account.32? 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use aspermitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.Who Pays the Corporate Income Tax?When the govt levies a tax on a corporation,the corporation is more like a tax collectorthan a taxpayer.The burden of the tax ultimately falls on people.Suppose govt levies a tax on automakers.Owners receive less profit, may respond over timeby shifting their wealth out of the auto industry.The supply of cars falls, car prices rise,car buyers are worse off.Demand for auto workers falls, wages fall,workers are worse off.The corporate income tax is popular among voters. After all, corporations are not people. V oters are always eager to have their taxes reduced and have some faceless corporation pick up the tab. But if the true incidence of the corporate income tax were widely understood, it might be much less popular.? 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.33Flat TaxesFlat tax: a tax system under which the marginal tax rate is the same for all taxpayersTypically, income above a certain threshold is taxed at a constant rate.The higher the threshold, the more progressivethe tax.Sharply reduces administrative burdenNot popular withpeople who benefit from the complexity of thecurrent system (accountants, lobbyists)people who can’t imagine life without theirfavorite deduction/loopholeUsed in some central/eastern European countries This material is based on a 2005 Economist article entitled “The Flat Tax Revolution.” This article appeared in a previous edition of the textbook in an “In the News” box.? 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.34CONCLUSION: The Trade-Off Between Efficiency and EquityThe goals of efficiency and equity often conflict:e.g., lump-sum tax is the least equitable butmost efficient tax.Political leaders differ in their views on thistradeoff.Economicscan help us better understand the tradeoffcan help us avoid policies that sacrificeefficiency without any increase in equitySummary?In the U.S., the most important federal revenue sources are the personal income tax, socialinsurance payroll taxes, and the corporateincome tax. The most important state and localtaxes are the sales tax and property tax.?The efficiency of a tax system refers to the costs it imposes on taxpayers beyond their taxpayments. One cost is the deadweight losscaused by the distortion of incentives from taxes.Another is the administrative burden ofcomplying with tax laws.? 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use aspermitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.Summary?The equity of a tax system refers to its fairness.The benefits principle suggests that it is fair forpeople to be taxed based on the amount ofgovernment benefits they receive. The ability-to-pay principle suggests that it is fair for people to pay taxes based on their ability to handle theburden.?The U.S. has a progressive tax system, in which high income taxpayers face a higher average tax rate than low income taxpayers.? 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use aspermitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.Summary?When evaluating the equity of a tax system, it is important to consider tax incidence, as thedistribution of tax burdens is not the same as the distribution of tax bills.?Policymakers often face a tradeoff between the goals of efficiency and equity in the tax system.Much of the debate over tax policy arisesbecause people give different weights to thesetwo goals.? 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use aspermitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.。