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Principles of Microeconomics : Ch.12 Second Canadian Edition Chapter 12 The Design of the Tax System © 2002 by Nelson, a division of Thomson Canada Limited.

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Presentation on theme: "Principles of Microeconomics : Ch.12 Second Canadian Edition Chapter 12 The Design of the Tax System © 2002 by Nelson, a division of Thomson Canada Limited."— Presentation transcript:

1 Principles of Microeconomics : Ch.12 Second Canadian Edition Chapter 12 The Design of the Tax System © 2002 by Nelson, a division of Thomson Canada Limited

2 Principles of Microeconomics : Ch.12 Second Canadian Edition Overview Financial Overview of the Canadian Government Taxes and Efficiency Taxes and Equity Conclusion

3 Principles of Microeconomics : Ch.12 Second Canadian Edition In this world nothing is certain but death and taxes. (Benjamin Franklin) In 1961, taxes accounted for about 28 % of total income! Percent of total income

4 Principles of Microeconomics : Ch.12 Second Canadian Edition In this world nothing is certain but death and taxes. (Benjamin Franklin) Today, taxes account for about 40 % of total income! Percent of total income

5 Principles of Microeconomics : Ch.12 Second Canadian Edition The Tax System When the government addresses the problem of externalities, provides public goods, or regulates the use of common resources, it can raise economic well-being. For the government to perform these and its many other functions, it needs to raise revenue.

6 Principles of Microeconomics : Ch.12 Second Canadian Edition The Tax System Most people agree that taxes should impose as small a cost on society as possible, i.e... … the tax system should be efficient and equitable.

7 Principles of Microeconomics : Ch.12 Second Canadian Edition A Financial Overview of the Canadian Government Where does the government get its income from? What does the government spend its income on?

8 Principles of Microeconomics : Ch.12 Second Canadian Edition The Canadian Federal Structure There are three levels of government - federal, provincial, local. The B.N.A. Act sets out the responsibilities of the federal and provincial governments. The local governments derive authority from the provincial governments. The Federal government has unlimited taxing powers.

9 Principles of Microeconomics : Ch.12 Second Canadian Edition The Federal Government: Revenue The major sources of tax revenue of the federal government include: –Personal Income Taxes –Corporate Income Taxes –Goods and Services Taxes –Payroll Taxes –Other

10 Principles of Microeconomics : Ch.12 Second Canadian Edition The Federal Government: Revenue

11 Principles of Microeconomics : Ch.12 Second Canadian Edition Personal Income Taxes... The largest source of government revenue Tax Liability is how much tax an individual owes and is based upon total income. Marginal Tax Rate is the tax rate applied to each additional dollar of income. Higher- income individuals pay a larger percentage of their income in taxes.

12 Principles of Microeconomics : Ch.12 Second Canadian Edition Federal Government Spending About 30% of total government spending is on servicing the public debt. The remaining 70% of government spending is called Program Spending.

13 Principles of Microeconomics : Ch.12 Second Canadian Edition Federal Government Spending

14 Principles of Microeconomics : Ch.12 Second Canadian Edition Financial Conditions of the Federal Budget Budget Deficit –Situation where the expenses of the budget are greater than the revenues. –Government finances the deficit by borrowing from the public. Budget Surplus –Situation where the revenues are greater than the expenses. Used to pay outstanding debts.

15 Principles of Microeconomics : Ch.12 Second Canadian Edition The Provincial Government: Revenue

16 Principles of Microeconomics : Ch.12 Second Canadian Edition The Provincial Government: Spending

17 Principles of Microeconomics : Ch.12 Second Canadian Edition Local Governments: Municipalities and School Boards Spending –Education –Protection of People and Property –Other Receipts –Property Taxes –Transfers –Other

18 Principles of Microeconomics : Ch.12 Second Canadian Edition Quick Quiz! What are the two most important sources of tax revenue for the federal government? What are the three most important expenditures for provincial governments?

19 Principles of Microeconomics : Ch.12 Second Canadian Edition Overview Financial Overview of the Canadian Government Taxes and Efficiency Taxes and Equity Conclusion

20 Principles of Microeconomics : Ch.12 Second Canadian Edition Taxes and Efficiency The aim of a tax system is to raise revenue for the government. Two objectives of designing a tax system: Efficiency Equity A tax system is more efficient if it can raise the same amount of revenue at a smaller cost to the taxpayers.

21 Principles of Microeconomics : Ch.12 Second Canadian Edition Related Costs of Taxes to Taxpayers The costs of taxes to taxpayers: –The tax payment itself Transfer of money from taxpayer to government. –Deadweight losses –Administrative burdens Again, an efficient tax system is one which minimizes these costs.

22 Principles of Microeconomics : Ch.12 Second Canadian Edition Deadweight Loss of Taxation When a tax is levied on buyers, the demand curve shifts downward by the size of the tax... When a tax is levied on sellers, the supply curve shifts upward by that amount... The losses to buyers and sellers exceed the tax revenue, leading to a Deadweight Loss.

23 Principles of Microeconomics : Ch.12 Second Canadian Edition Administrative & Compliance Costs Administrative Costs include: –Collection and enforcement expenses. Compliance costs include: –The time spent in early spring filling out forms. –Payment for tax experts in assisting the taxpayer in filing tax returns. The cost to the taxpayer is greater than the actual tax payment made.

24 Principles of Microeconomics : Ch.12 Second Canadian Edition The Goal of an Efficient Tax System An efficient tax system is one that imposes small deadweight losses and small administrative and compliance burdens. Suggested strategies to enhance efficiency include: –simplifying the tax system –broader based taxes

25 Principles of Microeconomics : Ch.12 Second Canadian Edition Alternative Tax Rates Efficiency and equity of income taxes leads to three notions of tax rates: Average Tax Rate......is total taxes paid divided by total income Marginal Tax Rate......is the extra taxes paid on an additional dollar of income Lump-Sum Tax Rate......everyone owes the same amount of tax

26 Principles of Microeconomics : Ch.12 Second Canadian Edition Quick Quiz! What is meant by the efficiency of a tax system? What can make a tax system inefficient?

27 Principles of Microeconomics : Ch.12 Second Canadian Edition Overview Financial Overview of the Canadian Government Taxes and Efficiency Taxes and Equity Conclusion

28 Principles of Microeconomics : Ch.12 Second Canadian Edition Taxes and Equity How should the burden of taxes be divided among the population? How do we evaluate whether a tax system is fair? Benefits Principle Ability-to-pay Principle

29 Principles of Microeconomics : Ch.12 Second Canadian Edition Taxes and Equity: Benefits Principle People should pay taxes based on the benefits they receive from government services. Example: –Gasoline Tax: These tax revenues are used to finance our highway system. –People who drive the most, use the road the most, also pay the most toward their upkeep.

30 Principles of Microeconomics : Ch.12 Second Canadian Edition Taxes and Equity: Ability-to-pay Principle Taxes should be assigned based on an individuals ability to shoulder the tax burden. Two notions of equity: Vertical Equity Horizontal Equity

31 Principles of Microeconomics : Ch.12 Second Canadian Edition Vertical Equity Differently situated individuals should be treated differently. Example: People with higher incomes should pay more than people with lower incomes. –Alternative Tax Systems: Proportional Regressive Progressive

32 Principles of Microeconomics : Ch.12 Second Canadian Edition Horizontal Equity Would require people of like incomes to pay the same amount of tax. Example: Two different families with the same number of dependents and the same income living in different parts of the country should pay the same federal taxes.

33 Principles of Microeconomics : Ch.12 Second Canadian Edition Taxes and Equity The difficult part of tax policy is to balance the sometimes conflicting nature of the efficiency and equity goals. The study of who bears the burden of taxes is central to evaluating tax equity. This is called Tax Incidence.

34 Principles of Microeconomics : Ch.12 Second Canadian Edition Quick Quiz! Explain the benefits principle and the ability-to-pay principle. What are vertical equity and horizontal equity? Why is studying tax incidence important in determining equity in a tax system?

35 Principles of Microeconomics : Ch.12 Second Canadian Edition Overview Financial Overview of the Canadian Government Taxes and Efficiency Taxes and Equity Conclusion

36 Principles of Microeconomics : Ch.12 Second Canadian Edition Conclusion: The tradeoff between equity and efficiency Equity and efficiency are the two most important goals of the tax system. But often these goals conflict. Many proposed changes in the tax laws increase efficiency while reducing equity, or increase equity while reducing efficiency.

37 Principles of Microeconomics : Ch.12 Second Canadian Edition Overview Financial Overview of the Canadian Government Taxes and Efficiency Taxes and Equity Conclusion


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