Why are we Taxed? Taxes and Spending

Lesson 8.1: Understanding Taxes

What Are Taxes? Taxes are required payments to either local, state, or the national government Revenue is the income received by a government from taxes and other nontax sources Needed so the government can operate and provide the public with goods and services Example: Building a Highway Police and Fire departments National Defense Fixing roads Cleaning sewer systems Maintaining powerlines

The Power to Tax First power granted to Congress in the Constitution Article 1, Section 8, Clause 1 The Congress shall have Power To lay and collect Taxes, Duties, Imposts and Excises, to pay the Debts and provide for the common Defense and general Welfare of the United States; but all Duties, Imposts and Excises shall be uniform throughout the United States This clause is the basis for federal tax laws.

Limits on the Power to Tax The purpose of a tax must be for the “common defense and general welfare” Taxes cannot go towards individual interests Taxes must be the same in every state The Federal Government cannot charge each state different types of taxes Constitution limits the kinds of taxes Congress can impose Ex: It cannot tax church services because it violates freedom of religion in the first amendment in the Bill of Rights The constitution prohibits the taxation of exports Can prohibit the export of certain goods such as weaponry or technology Allows the taxation of imports Article 1, Section 9, Clause 4: prohibits congress from levying or imposing, taxes unless they are divided among the states according to population

Direct taxes - levied directly on individuals and paid directly to the government. Ex: Federal income tax and Medicare tax Indirect taxes – levied on certain products rather than directly on individuals (sales and excise taxes). The government gets the tax indirectly.

Tax Structures Proportional Tax – Progressive Tax – Regressive Tax – Imposes same percentage on every taxpayer Example: Flat Tax Progressive Tax – Higher percentage on persons with higher income Example: Current Income Tax Regressive Tax – Higher percentage on persons with lower income Example: Sales Tax

Tax Structures Type of Tax Example: Description Proportional Ron’s taxes on $50,000 income Mary’s taxes on $150,000 income Proportional A constant percentage of income is taken in taxes as income increases “Flat” tax $7,500, or 15 percent of income $22,500 or 15 percent of income Progressive A larger percentage of income is taken in taxes as income increases Income tax $5,000, or 10 percent of income $45,000, or 30 percent of income Regressive A smaller percentage of income is taken in taxes as income increases Sales tax $2,000, or 5 percent of total purchases of $40,000; tax bill is 4 percent of income $3,000, or 5 percent of total purchases of $60,000; tax bill is 2 percent of income

Our Progressive Tax System: A Layered Cake 39.6% $415,050 and up 35% $413,350-$415,050 33% $190,150-$413,350 28% $91,150-$190,150 25% $37,650-$91,150 15% $9,275-$37,650 10% $0-$9,275 (for someone filing SINGLE on their Tax forms)

This graph of a 2013 study shows the share of income paid in state sales and excise taxes at different income levels.

Tax Bases A Tax base is the income, property, good, or service that is subject to a tax. Income, Wealth and Consumption What Taxes are taken: Individual income: tax on a person’s earnings Sales tax: a tax on the dollar value of a good or service being sold Property tax: a tax on the value of a property Corporate income tax: a tax on the value of a company’s profits

The Tax Burden Government tax policies have a real impact on millions of individuals and businesses. These impacts can affect the entire economy. Thus, it is important to think about who actually bears the burden of a tax. This is not necessarily the person who sends in the money to pay the tax bill. How can we know who is actually bearing the burden of a tax? The answer lies in supply-and-demand analysis.

Elasticity of demand for a product affects whether consumers or businesses bear the burden of a tax on it. Why does the burden shift to businesses if demand is elastic?

This graph shows the effect of a tax when the demand for the good being taxed is inelastic. Do you think consumers or businesses will pay the larger share of the tax? Explain.

Determining fairness Benefits-received principle: a person should pay taxes based on the level of benefits they expect to receive Ability-to-pay principle: pay taxes according to ability to pay, people who earn more pay more taxes Incidence of tax- final burden of the tax (who is actually paying) Producers can pass a tax on their products to consumers by raising their prices

Key Characteristics of a Tax Although it is sometimes difficult to decide whether a specific tax is proportional, progressive, or regressive, economists do generally agree on the qualities a tax ought to have. A tax should have four characteristics: Simplicity: easy for everyone to understand Efficiency: collecting and paying in a timely manner Certainty: no miscommunications in when and how much money is due Equity: Should be fair so no one bears too much or too little of the tax burden

Key Characteristics of a Tax The government’s Internal Revenue Service (IRS) has a “long form” and a simpler “short form” for filing taxes. What does this cartoon suggest about the tax system?

Key Characteristics of a Tax In addition to the taxes graphed here, governments may also collect sales and other taxes.

Lesson 8.2: Federal Taxes

Individual Income Taxes: a tax that governments impose on financial income generated by all individuals within their jurisdiction. Individual Tax Brackets: a range of incomes taxed at a given rate (The Layer Cake) Tax Withholding: the amount of an employee's pay withheld by the employer and sent directly to the government as partial payment of income tax. Filing a Tax Return: By law, businesses and individuals must file an income tax return every year to determine whether they owe any taxes or are eligible for a tax refund. Corporate Income Taxes: An assessment levied by a government on the profits of a company.

Individual and Corporate Income Taxes Based on this graph, what effect would an economic downturn, with lower corporate and individual earnings, have on government receipts? Explain.

Government Revenue Revenue: Income of a government from taxation, or other sources used to the pay public expenses Individual Income Tax - #1 source of Government revenue, nearly 50% of total revenue FICA Taxes – Social Security taxes, levied on both employee and employer to pay for Social Security and medicare. Corporate Income Taxes – Tax corporation pays on its profits

Government Tax Revenue Income Taxes: $2.2 trillion Social Insurance Taxes: $1.1 trillion Business and other: $0.3 trillion

Other sources of Government Revenue Excise Taxes – tax on selected items, liquor, tobacco, and gasoline (4th largest source of government income) Estate and Gift Taxes – Estate tax is a levied on transfer of property when person dies Gift tax is levied on donations or wealth given to another person. (set up to close loophole of wealthy people giving away their money before death to keep from paying estate tax) Tariffs- Taxes on Imports

Tariffs today are mainly intended to protect American farms and businesses from foreign competition The Estate Tax

Social Security, Medicare, and Unemployment Taxes Federal Insurance Contributions Act: FICA taxes that fund Social Security and Medicare Social Security Taxes go towards Old-Age, Survivors, and Disability Insurance (OASDI) Started after the Great Depression, originally to provide retired people with old-age pensions Medicare a national health insurance program that helps pay for health care for people over age 65 or with certain disabilities

Social Security, Medicare and Unemployment Taxes Unemployment Taxes issued by the government as an insurance policy for workers When laid off one can file an “unemployment compensation” claim and collect benefits for a fixed number of weeks Usually to collect benefits one must show that they are actively searching for another job The unemployment program is funded by both federal and state taxes

The gap between what Medicare takes in and what it spends has been widening. What are two possible solutions to the problem presented by this graph? **Receipts: revenue coming in

Lesson 8.3: Federal Spending

Mandatory and Discretionary Spending Mandatory Spending- spending on certain programs that are mandated, or required, by existing law Discretionary spending- Government planners can make choices on where to spend money

What is the largest spending category in the budgets represented here?

Entitlement Programs Entitlement- social welfare program that people are “entitled to” if they meet certain eligibility requirements Social Security largest category of federal spending, serves more than 45 million Medicare serves about 36 million people most of whom are 65 or older Medicaid which is insurance that serves low-income families

Government Entitlements Except for interest on the national debt, most of the mandatory spending items in the federal budget are for entitlement programs. Entitlements are social welfare programs that people are “entitled to” and benefit from if they meet certain eligibility requirements, such as being at a particular income level or age. The federal government guarantees assistance for all those who qualify. As the number of people who qualify rises, mandatory spending rises as well. As a result, managing the cost of entitlement programs has become a major concern.

Government Entitlements Social Security Medicare Medicaid Other Mandatory Spending Programs

Entitlement Programs Other Mandatory Spending Programs such as means-tested entitlements benefits that help people and families whose incomes fall below a certain level Such as food stamps, supplemental security income (SSI), and child nutrition (WIC) The federal government also pays retirement benefits and insurance for federal workers, as well as veterans’ pensions and unemployment insurance

A growing share of the budget is devoted to mandatory spending A growing share of the budget is devoted to mandatory spending. What does this graph show about the relationship between mandatory and discretionary spending?

As the nation gets older, the top of the population pyramid gets larger. Compared to 1980, how will the ratio of workers to Social Security recipients have changed by 2035?

Spending on Discretionary Programs Defense Spending Other Discretionary Spending Federal Aid to State and Local Governments

Spending on Discretionary Programs Inspectors prepare to examine shipping containers for terrorist threats. Why is the share of the budget that funds such discretionary activities shrinking?

8.4 State and Local Taxes and Spending

State and Local Taxes The three most important state and local taxes are the sales tax, property tax, and the state individual income tax. Sales tax – an indirect regressive tax levied on most products. The sales tax in Houston is 8.25% percent of every dollar. Only 5 states, Alaska, Delaware, Montana, New Hampshire, and Oregon – do not have a sales tax. On average, a family of four, pays about $1500 a year on the sales tax. Texas has a 6.25% sales tax and the city of Houston has 2%

State individual income tax – taxed by either the “graduated” or “flat-rate” Texas is one of 7 states with no state individual income tax. Americans pay about 29 cents of every dollar in taxes. Tax breaks cost $400 billion in lost revenue each year. Property Tax – tax on assets (mainly a tax on land and buildings). Taxes are also on furniture, autos, farm animals, stocks, bonds, and bank accounts. Used to finance education, police and fire protection. Regressive Tax: if two people own separate $100,000 homes, they both pay the same tax.

State Sales Tax (State and Local) Tennessee 9.45% Arkansas 9.26% Alabama 8.91% Louisiana Washington 8.89% Oklahoma 8.77% New York 8.48% California 8.44% Kansas 8.20% Illinois 8.19% Arizona 8.17% Texas 8.05% Nevada 7.94% Missouri 7.81% State Sales Tax (State and Local) Alaska 1.76% (local only) Delaware None Montana New Hampshire Oregon

*They tend to have more regressive tax systems.

Sources of State Revenue Intergovernmental revenue – fund collected by one level of government and passed to another level of government (i.e. federal to state) EXAMPLES: Education, Healthcare, Transportation and Community Development Taxes and fees – a tax is levied on the sale of nearly all products (Sales, Excise, Property, Corporate) FEE EXAMPLES: Licenses, Registrations (Fishing, Hunting, Vehicle, Anything with a motor) Personal Income Taxes: Texas does not have State Income Taxes

Texas Tax Revenue [mainly regressive] Oil production 2% Insurance Taxes 4% Natural Gas 5% Bus. franchise Tax 9% Sales Tax 61% Motor Fuels 11% (R) Alcoholic bev. 2% (R) Motor Vehicle Sales 10% (R) Texas gets most of its revenue from the sales tax.

% of income of a family of 4 in state/local taxes (TX) How much income goes to State and Local Taxes?? % of income of a family of 4 in state/local taxes (TX) 7.6 4.2 3.3 3.0 2.9 2.5 1.5 6.8 5.0 4.0 3.5 2.3 2.7 1.1 0.9 20% 18% 16% 14% 12% 10% 8% 6% 4% 2% Excise Tax Sales Tax Property Tax 17.1% 10.7% 8.4% 7.4% 6.4% 5.1% 3.1% $10,812 $23,100 $35,300 $51,400 $80,400 $180,000 $945,500 Average Annual Income Taxes Per Year: $1,812 $2,472 $2,965 $3,804 $5,470 $9,180 $29,311

State/Local Spending Operating budget- pays for day-to-day expenses Salaries of State employees Maintenance: State buildings/facilities Capital budget- major investments or expenditures Building a new bridge or building State Operating budget must be balanced Limits on taxes (Tax-exempt) Churches Non-profits

Local Government Revenue Intergovernmental revenue – about 1/3 of the revenue Property tax – tax on intangible and tangible possessions Examples: real estate, buildings, furniture, automobiles, farm animals, stocks, bonds, and bank accounts Goes to supporting local schools, Police and Fire and to maintain local streets Sales tax – up to 2 percent of the state mandated sales tax

STATE AND LOCAL Spending Operating Budget: Plan for the day to day spending needs Salaries of state employees Supplies needed Maintain of state facilities Such as recreation areas and parks Capital Budget: Pays for major capital/investment Used to build infrastructure such as bridges Items are planned for years in advance of building/creating

STATE AND LOCAL Spending State Expenditures: Education Public Welfare Examples: welfare programs (SNAP,TANF, disability) Health and Hospitals Highways Public Safety and Environment Examples: Police and Fire, Corrections, Parks and Recreation