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.