Sources of Government Revenue

Economic Impact of Taxes Resource Allocation Factors of production are affected Raise in production costs Higher prices = less demand = increase unemployment

Economic Impact of Taxes Behavior Adjustment Encourage or discourage certain activities “sin tax”: high % tax that raises revenue while reducing consumption of a socially undesirable product

Economic Impact of Taxes Productivity – Change incentives to save, invest, and work The Incidence of a Tax – The party being taxed is not always the one that bears the burden of a tax. – Higher taxes on utility company = higher utility bills

Criteria for Effective Taxes Criterion One: Equity – Fairness is subjective – Tax loopholes: Can they be avoided? – Taxes are generally viewed as fair if there are fewer exemptions, exceptions, and deductions

Criteria for Effective Taxes Criterion Two: Simplicity Tax laws should be easy to understand

Criteria for Effective Taxes Criterion Three: Efficiency Easy to administer and can generate revenue easily

Two Principles of Taxation Benefit Principle Those who benefit from the government should pay in proportion to the amount of benefits they receive Gasoline: If you drive more, then you pay more gas tax = more $$ for highway upkeep Two limitations: – Most government benefits go to those least able to pay for them – Benefits are hard to measure

Two Principles of Taxation Ability-to-Pay Principle People should be taxed according to their ability to pay, regardless of benefits received Ex: individual income tax Two factors: Benefits derived from government spending cannot always be measured Assumes higher income earners suffer less discomfort in paying taxes than lower income earners

Types of Proportional Imposes the same tax rate % on everyone, regardless of income As income increases, the % of income tax stays the same. If tax rate is 20%, a person making $10,000 pays? A person making $100,000 pays?

Types of Taxes Progressive Tax Imposes a higher tax rate % on persons with higher incomes Ex? Income Tax As income increases, the % of income paid in taxes also goes up

Types of Regressive Tax Example? State sales tax As income goes up, the % of income paid in taxes goes down – Someone making $10,000/yr may spend $5,000 on food and clothing – Someone making $100,000 may spend $20,000 on same essentials If state sales tax is 4%, the lower income household is paying a higher % of total taxes

Section 2: The Federal Tax System Individual Income Taxes Gov collects about 48% of revenue from individual income tax W/held from individual’s paychecks, with employers sending taxes directly to IRS Individuals file a tax return on/before April 15 each year. – If taxes w/held > taxes owed = refund – If taxes w/held < taxes owed = individual pays balance

FICA Federal Insurance Contributions Act – Largest source of government revenue – Regressive Medicare Social Security Taxes: Partially proportional, partially regressive

Quiz 1. What are the 3 the criteria for effective taxes? 2. What are the 2 principles of taxation? 3. What are the 3 types of taxes? 4. What two areas or taxes make up FICA? 5. What percentage of revenue is collected by the Federal Government in the form of income tax? 6. What is a progressive tax? 7. What is a regressive tax? 8. What does FICA stand for?