2-1 Tax Policy A broad definition: government’s attitude, objectives, and actions with respect to its tax system The details of the tax system should.
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2-1 Tax Policy A broad definition: government’s attitude, objectives, and actions with respect to its tax system The details of the tax system should be consistent with overall tax policy Tax policy should reflect the normative standards government deems important
2-2 Criteria for a ‘Good’ Tax Convenient Sufficient Fair (equitable) Efficient
2-3 Sufficient Revenue Collections Recall:T = r B How to increase tax revenues (T): Enact a new tax on a base not currently taxed Increase the tax rate (r) Increase (expand) the tax base (B) The politics of tax increases Why is it not simple to determine the impact of such changes?
2-4 Behavioral Response to Tax Changes Income effect - taxpayers respond to an increase in tax burden by earning more before-tax income, so is to maintain their pre-change after-tax earnings Substitution effect - taxpayers respond to an increase in tax burden by earning less - labor/leisure trade-off Both types of responses complicate forecasting Static versus dynamic forecasting
2-5 Tax Fairness/Equity T = function(ability to pay) Horizontal equity - taxpayers with the same ability to pay should pay the same amount of tax Vertical equity - taxpayers with greater ability to pay should pay a greater amount of tax Redistribution of wealth
2-6 Tax Rate Structures and Vertical Equity Progressive rates Tax rates increase as base increases Used to promote vertical equity, based on the theory of declining marginal utility of income Regressive rates Tax rates decrease as base increases Regarded as unfair to lower income taxpayers Proportional (flat) rates Often regarded as implicitly regressive
2-7 Tax Rate Comparisons Average tax rate - the explicit tax paid divided by the tax base Marginal tax rate - the rate that applies to any incremental increase in tax base Will the average tax rate be >, =, or < the marginal tax rate when rates are progressive, regressive, or proportional?
2-8 Efficiency Tax neutrality Taxes as an instrument of fiscal policy macroeconomic effects behavior modification
2-9 Evaluating the US Income Tax Is the US income tax system: Convenient? Sufficient? Fair? Efficient? Which of these goals might motivate recent proposals to change the system?
2-10 The Source of Federal Tax Law Legislative process: Any new tax bill is first introduced in the House of Representatives, and referred to the Ways and Means Committee A bill approved by Ways and Means is sent back to the full House for approval A bill approved by the House is sent to the Senate, where the Finance Committee has jurisdiction
2-11 Source of Tax Law continued The Senate Finance Committee may amend the House bill, and send to the full Senate for approval If the House and Senate approved versions of the bill differ, a Joint Conference Committee must resolve differences The final bill must be approved by both House and Senate, before being sent to the President
2-12 Structure of the Federal Tax Law Primary authority – three types Statutory authority - Internal Revenue Code of 1986 Administrative authority Treasury Regulations - have authoritative weight similar to the Code IRS Rulings –Revenue Rulings - guidance published by the IRS for ambiguous or contentious situations. Not binding authority unless the facts are the same. –Revenue Procedures - explain procedures and other taxpayer duties
2-13 Structure of the Tax Law continued IRS Rulings continued –Private Letter Rulings - the IRS makes an advanced ruling on a specific transaction at the request of a taxpayer. Represents authority only for that transaction and that taxpayer! Judicial authority Court Decisions - establish precedent on interpretation of the tax law –Trial Courts: Tax Court, District Courts, Federal Claims Court –Appeals Courts: Circuit Courts of Appeal, US Supreme Court
2-14 Structure of the Tax Law continued Congressional intent - Committee reports of: House Ways and Means Committee Senate Finance Committee Joint Conference Committee Secondary authority Textbooks, editorial materials in commercial tax services, professional journals Useful for understanding primary sources, but not authoritative. Should not be cited!
2-15 The Tax Research Process Step 1: Understand the client’s transaction and ascertain the facts. Step 2: Identify the tax issues, problems, or opportunities suggested by the facts and formulate specific research questions. Step 3: Locate relevant tax law authority. Step 4: Analyze relevant authority and answer the research questions.
2-16 The Tax Research Process continued Step 5: Repeat steps 1 through 4 as many times as necessary. Step 6: Document your research and communicate your conclusions.