Continuing taxes Deficit financing Today: More on the US revenue system, including the corporate tax; Deficit financing

Today 4 “mini-lectures”  Other issues with personal income taxes The marriage penalty International income  Changes in personal behavior due to taxation Number of hours worked Saving  Corporate taxation (briefly)  Deficits and debts

Marriage penalty/Int’l income Previously…  Rate structure showed that there are different tax rates for married people than for single people In this “mini-lecture…”  We examine the marriage issue further  Income earned by Americans in other countries is also looked at

The marriage penalty There are many reasons that people in the United States decide not to marry  Costly to divorce if the marriage does not work out well  Many low-income people may lose benefits People receiving public assistance may lose qualification for these programs if they marry someone who is working  Tax burden may increase as a married couple than as if they lived together unmarried

Example of the marriage penalty: Taxes Suppose a simple case  Only taxable income determines taxes that have to be paid See what happens to tax burden when some couples get married

Recall marginal tax rates, 2007 Official Statutory Tax Rate Schedule (2007) Single ReturnsJoint Returns Taxable IncomeMarginal Tax Rate Taxable IncomeMarginal Tax Rate $0-$7,82510%$0-$15,65010% $7,825-$31,85015$15,650-$63,70015 $31,850-$77,10025$63,700-$128,50025 $77,100-$160,85028$128,500-$195,85028 $160,850-$349,70033$195,850-$349,70033 $349,700 and over35$349,700 and over35 Source:

Example 1, single Cameron has $80,000 in taxable income  Tax burden: $16, total 10% of $7,825 15% of $24,025 25% of $45,250 28% of $2,900 Erin has $80,000 in taxable income  Tax burden: $16, total 10% of $7,825 15% of $24,025 25% of $45,250 28% of $2,900 Official Statutory Tax Rate Schedule (2007) Single ReturnsJoint Returns Taxable Income Marginal Tax Rate Taxable Income Marginal Tax Rate $0-$7,82510%$0-$15,65010% $7,825- $31,850 15$15,650- $63, $31,850- $77,100 25$63,700- $128, $77,100- $160,850 28$128,500- $195, $160,850- $349,700 33$195,850- $349, $349,700 and over 35$349,700 and over 35 As single people, Cameron and Erin pay a total of $33, in taxes

Example 1, married Cameron and Erin get married Total taxable income is $160,000  Tax burden: $33, total 10% of $15,650 15% of $48,050 25% of $64,800 28% of $31,500 $771 more than the total paid if they are single Official Statutory Tax Rate Schedule (2007) Single ReturnsJoint Returns Taxable Income Marginal Tax Rate Taxable Income Marginal Tax Rate $0-$7,82510%$0-$15,65010% $7,825- $31,850 15$15,650- $63, $31,850- $77,100 25$63,700- $128, $77,100- $160,850 28$128,500- $195, $160,850- $349,700 33$195,850- $349, $349,700 and over 35$349,700 and over 35

Example 2, single Pat has $30,000 in taxable income  Tax burden: $4, total 10% of $7,825 15% of $22,175 Shannon has $200,000 in taxable income  Tax burden: $52, total 10% of $7,825 15% of $24,025 25% of $45,250 28% of $83,750 33% of $39,150 Official Statutory Tax Rate Schedule (2007) Single ReturnsJoint Returns Taxable Income Marginal Tax Rate Taxable Income Marginal Tax Rate $0-$7,82510%$0-$15,65010% $7,825- $31,850 15$15,650- $63, $31,850- $77,100 25$63,700- $128, $77,100- $160,850 28$128,500- $195, $160,850- $349,700 33$195,850- $349, $349,700 and over 35$349,700 and over 35 As single people, Pat and Shannon pay a total of $56,177 in taxes

Example 2, married Pat and Shannon get married Total taxable income is $230,000  Tax burden: $55,100 total 10% of $15,650 15% of $48,050 25% of $64,800 28% of $67,350 33% of $34,150 $1,077 less than the total paid if they are single Official Statutory Tax Rate Schedule (2007) Single ReturnsJoint Returns Taxable Income Marginal Tax Rate Taxable Income Marginal Tax Rate $0-$7,82510%$0-$15,65010% $7,825- $31,850 15$15,650- $63, $31,850- $77,100 25$63,700- $128, $77,100- $160,850 28$128,500- $195, $160,850- $349,700 33$195,850- $349, $349,700 and over 35$349,700 and over 35

Why the difference? Look at marginal tax rates and the cut-offs

Example 1: Cameron/Erin, $80K each Official Statutory Tax Rate Schedule (2007) Single ReturnsJoint Returns Taxable IncomeMarginal Tax Rate Taxable IncomeMarginal Tax Rate $0-$7,82510%$0-$15,65010% $7,825-$31,85015$15,650-$63,70015 $31,850-$77,10025$63,700-$128,50025 $77,100-$160,85028$128,500-$195,85028 $160,850-$349,70033$195,850-$349,70033 $349,700 and over35$349,700 and over35 More income is taxed in the 28% bracket after they get married

Example 2: Pat $30K/Shannon $200K Official Statutory Tax Rate Schedule (2007) Single ReturnsJoint Returns Taxable IncomeMarginal Tax Rate Taxable IncomeMarginal Tax Rate $0-$7,82510%$0-$15,65010% $7,825-$31,85015$15,650-$63,70015 $31,850-$77,10025$63,700-$128,50025 $77,100-$160,85028$128,500-$195,85028 $160,850-$349,70033$195,850-$349,70033 $349,700 and over35$349,700 and over35 As a married couple, less income is taxed in the 28% and 33% brackets; more in the 25% bracket

Two reasons that this happens When there is one person that earns almost all of the income, more money is usually subject to the lower marginal rates  Notice that the two lowest brackets vary by a factor of two At the higher brackets, the income ranges converge  Notice that the 35% bracket is the same whether or not you are married Official Statutory Tax Rate Schedule (2007) Single ReturnsJoint Returns Taxable Income Marginal Tax Rate Taxable Income Marginal Tax Rate $0-$7,82510%$0-$15,65010% $7,825- $31,850 15$15,650- $63, $31,850- $77,100 25$63,700- $128, $77,100- $160,850 28$128,500- $195, $160,850- $349,700 33$195,850- $349, $349,700 and over 35$349,700 and over 35

For more on the marriage penalty… Read p  Three principles, including marriage neutrality  Changes to the marriage penalty over the years  Is the marriage tax equitable? Is the marriage tax efficient? Argument in favor of family as taxable unit: “Bedchamber transfers of property” from high-earning spouse to low-earning spouse could be a risky strategy Argument in favor of individual as taxable unit: Elasticity of labor supply differs between men and women  What is a family?

International income The United States uses a global taxation system  Income is taxed no matter where it is earned  Credit is given for taxes paid to other countries, up to the total tax liability Most other countries use a territorial system  Someone earning income outside of her home country only pays taxes to the country where the money was earned

Summary: Marriage penalty/int’l income When two single people marry, the combined tax burden typically changes  Example 1: Equal incomes by both spouses Tax burden goes up  Example 2: Big differences in income between the two spouses Tax burden goes down International income is taxed differently depending on the country you are a citizen in

Changes in behavior due to taxation Although taxation typically is on income, it is indirectly based on other types of decisions  Labor decisions  Saving decisions

Labor decisions Taxes reduce the marginal wage that a person receives How do taxes alter people’s behavior? See Figure 18.1, p. 416 See Figure 18.2, p. 417 See Figure p. 418 See Figure 18.4, p. 418

Empirical literature Who responds to changes in tax rates?  Women Example: Tax Reform Act of 1986 (TRA86)  Marginal tax rates for high incomes were decreased significantly  Women with husbands earning a lot increased their work by a lot (on average)  Women with husbands earning moderate amounts increased their work by a smaller amount (on average)  For more, see Eissa (2001)

The Laffer curve Is there a limit to the amount of tax revenue that the government can get through a labor tax?  Yes As tax rates increase, people have less of an incentive to work  Look at a simple example See Figure 18.5, p. 422

The Laffer curve Eventually, increasing the tax rate will lower tax revenue collected  This leads to the question: What is the tax rate that maximizes labor taxes that are collected? This idea was popularized by Arthur Laffer  See Figure 18.6, p. 423

Changes in saving How does saving change when interest is taxed and interest payments are deductible  See Figure 18.7, p. 426  See Figure 18.8, p. 427  See Figure 18.9, p. 427

Empirical literature There appears to be very little change in saving due to the tax system  Not much research has been done to conclusively answer this question, however

Summary: Changes in behavior Theory is unclear as to how people change their labor and saving decisions when taxes change  Empirical evidence shows that women with high- earning husbands increase their labor supply significantly when marginal tax rates decrease  Saving does not seem to be affected by tax laws The Laffer curve predicts that there is a tax rate that maximizes total tax revenue collected

Corporate taxation Corporations are businesses that usually determine ownership through stocks  Limited stockholder liability  Legal entities Corporations provide about 10% of federal taxes collected

Corporate taxation Reasons supporting corporate taxation  Corporations are distinct financial entities  Limited liability gives corporations a big advantage over non-corporate businesses  Without the corporate tax, no tax money is collected if profits are retained by the corporation Reason against supporting corporate taxation  Double taxation Taxation occurs at the corporate and individual levels

Corporate taxation Structure of the corporate tax  Graduated  Most corporate taxes paid are at the highest bracket: 35% What can be deducted?  Employee compensation  Interest  Direct costs of doing business Note that depreciation of capital occurs over time

Basic structure Revenue - Expenses incurred earning revenuesExpenses incurred earning revenues Taxable Income * Tax rate (15% - 35%) Tax - Credits Total Tax

More on corporate taxation If you are interested in corporate taxation, you can read other topics in Chapter 19  Corporate behavior  Corporate finance  State corporation taxes  Taxing multinational corporations  Reform You are only responsible for knowing pages

Summary: Corporate taxation Corporations are independent legal entities Stockholders of corporations have limited legal liability Corporate earnings are taxed  Different system than for individual taxes

Debts and deficits in the US Debt by the US government has been a significant percentage of GDP for decades “Official” government debt at the end of 2005  $4.6 trillion, or $4,600,000,000,000  A better way of seeing this is that this is about 37% of yearly national GDP See Figure 20.2, p. 464

Some terminology Two “flow” terms  Deficit “The excess of expenditures over revenues during a period of time” (R/G p. 462)  Surplus “The excess of revenues over spending during a period of time” (R/G p. 462) One “stock” term  Debt “The total amount owed at a given point in time; the sum of all past deficits” (R/G p. 462)

Some terminology On-budget versus off-budget deficit  Some revenues and expenditures are considered “on-budget”  Some programs, like Social Security, are considered “off-budget”

The US federal deficit Over the last 40, the US federal government has incurred a deficit almost every year  On-budget deficit in 2005: $493.6 billion  Off-budget surplus in 2005: $175.3 billion  Total deficit in 2005: $318.3 billion See Figure 20.1, p. 463, for deficits and surpluses since 1965

Two other factors Not all “promises” made by the US government are calculated in the official debt numbers  Social Security (SS)  Medicare  However, SS and Medicare policies can be revised by the federal government as it pleases The US government has many assets, including land, gold, and buildings For more factors, see p

What are the effects of public debt? Lerner’s view  When debt is held by its own citizens, there is no burden for future generations Note that Lerner views a generation as anyone alive at the same time  When future debt is paid off, bondholders are paid off by other people in the same generation Reality  In the US, about 53% of privately held federal debt is held by foreigners

What are the effects of public debt? Overlapping generations model  Think of each generation as being 20 years long  There is no private saving  The old do not lend to the government, since they will die before the debt is repaid

Overlapping Generations Model The Period YoungMiddle-AgedOld (1) Income$12,000 12,000 (2) Government Borrowing-6,000 (3) Government- provided consumption 4,000 The Year 2027 YoungMiddle-AgedOld (4) Government raises taxes to pay back debt -4,000 (5) Government pays back debt+6,000

What are the effects of public debt? Other factors are important in determining the effects of public debt  Crowding out hypothesis Public debt decreases private investment Market interest rate increases  Bequest effect comes into play if the oldest generation care about future generations

Summary: Debts and deficits in the US US debt has been about 30-50% of GDP since the early 1980s On-budget deficits and debts calculated by the US government do not account for all assets and liabilities Many factors affect the outcomes of public debt

Next lecture Wrap up the material of this class  Tax reform Read p  State and local governments Read Chapter 22