Taxes & Government Spending

What is a tax? A required payment to a local, state, or national government Why are taxes collected? Taxation is the primary way that the government collects money (revenue) that is used to provide goods and services to us.

I. The Economics of Taxations A. Impact of Taxes 1. Resource Allocation a. When a tax is placed on a good, the cost of production rises, the demand decreases, and the price rises. b. Production may be moved or allocated to another industry or go unused. 2. Behavior Adjustment a. Sin Tax – a high tax designed to lower consumption of a socially undesirable product 1). Examples – liquor and tobacco b. Raises government revenue 3. Productivity and Growth a. High income taxes can cause people to lose their incentive to work. b. High income taxes can cause businesses to lose their incentive to continue their business. c. High taxes may cause people to be able to save less money.

B. Criteria for Taxes 1. Equity a. Defining the equity or fairness of a tax may be the most difficult task in creating a tax. 1). Some feel that a fair tax is when everyone pays the same amount no matter what their income is. 2). Some feel that wealthier people should pay more than people with low incomes. b. Tax Loophole 1). Exception or oversight in the tax laws that allows some people and businesses to avoid paying certain taxes 2. Simplicity a. Tax laws should be written so that tax collectors as well as tax payers can understand them. b. Confusing tax forms tend to make people more apt to try to avoid paying the tax. 3. Efficiency a. The tax should be easy to administer and a good revenue generating device. b. Costs of implementing the tax should be far less than the money brought in by the tax.

C. Two Principles of Taxation 1. Benefit Principle a. Two main ideas 1). Those who benefit from government services should be the ones to pay for them 2). People should pay taxes proportional to the services they receive a). Example: gasoline – those who buy gasoline benefit because the tax on gas goes to help improve roads and bridges, hence, those who buy more gas and use more roadway, will pay more in taxes. b. Limitations 1). Those who receive more benefits (usually the poor) have less means to pay into them (welfare) 2). Benefits are hard to measure

3. Ability-to-Pay Principle a. people are taxed according to their ability to pay b. people who make or save more, pay more

Types of Taxes 1.Proportional 2.Progressive 3.Regressive

Proportional Taxes Definition: The percentage of income paid in taxes remains the same for all income levels. –A 6% proportional income tax Leslie (a CEO) makes $350,000/yr and Tony (a nurse) makes $50,000/yr. Leslie pays 6% of her $350,000 ($21,000) Tony pays 6% of his $50,000 ($3,000) Example: Income tax in Estonia, Slovakia, & other European Countries

Progressive Taxes Definition: The percentage of income paid in taxes increases as income increases. Example: U.S. federal income tax INCOME ($)TAX (%) 14,000-17,50012 % 25,500-28,25017 % 31,000-34,70019 % 44,200-47,40021 % 56,500-59,80023 % 67,600-72,90025 % 95,200-99,00027 %

Regressive Taxes Definition: A single tax rate is applied to everyone. The percentage of income paid in taxes decreases as income increases. –Although the tax rate remains constant… –Higher-income households spend a lower proportion of their incomes on taxable goods and services. –The proportion of their income spent on sales taxes is lower than that of lower-income households. Example: Sales tax

II. The Federal Tax System A. Individual Income Taxes (Most important federal tax) 1. Under the 16th Amendment (1913) Congress has the “power to lay and collect taxes on incomes” 2. Payroll Deductions a. Payroll Withholding System 1). An employer uses federal tax tables to estimate the amount of taxes a worker would pay on a given paycheck 2). Sends that money directly to the government a). IRS – Internal Revenue Service 3). By April 15th of each year, employees must file a report with the federal government outlining their income, deductions, and taxes already paid from withholdings. a). The difference in what is owed (determined by tax tables) must be paid by the employee. b). If the employee has paid more than they need to, they receive a tax return.

3. A Progressive Income Tax a. Our current income tax structure is a progressive income tax 1). As you make more money, your tax rate goes up b. See income tax tables 4. Indexing a. a system used to adjust tax brackets in line with inflation

B. FICA Taxes (2nd most important federal tax) 1. FICA – Federal Insurance Contributions Act 2. Social Security Taxes a. Since 1990, Social Security’s Old Age, Survivors, and Disability Insurance has been taxed at a rate of 6.2% 1). The maximum amount paid into the system stops at a $90,000 income (2005) 2). Once your income goes above $90,000, you do not pay more than $5,580, even if you make 1 million per year b. Social Security is a proportional tax up to $90,000 in income but then becomes a regressive tax 3. Medicare a. Since January 1, 1994, Medicare has been a proportional tax at 1.45% at all income levels

C. Corporate Income Taxes (3rd most important federal tax) 1. Taxes collected on the incomes made by corporations 2. Tax is slightly regressive 3. Corporate Income Tax Rates are much like personal rates D. Other Federal Taxes 1. Excise Tax a. a tax on the manufacture or sale of certain items b. Examples: gasoline, liquor, betting (entertainment tax) 2. Estate Tax a. tax the government places on the transfer of property when a person dies b. Tax can range from 18% to 55% depending on value of estate c. Estates under a set amount by the government are exempt ($600,000 in 1995)

3. Gift Taxes a. a tax on donations of money or wealth b. paid by the person who makes the gift c. used to deter people from avoiding taxes by giving away their money before they die d. makes college contributions to children’s savings accounts very difficult 4. Customs Duties a. Tariffs: A charge levied on goods brought into the country from other countries b. duties cover all types of products but rates are usually very low 1). Duty-Free shops often seen on boarders 5. Miscellaneous Fees a. Users Fees 1). Example: Paying a fee to enter a National Park

Where do your U.S. tax dollars go?

III. State and Local Tax Systems A. State Government Revenue Service (How do States make $) 1. Sales Tax a. a tax levied on consumer purchases b. money is the turned over to the state on either a weekly or monthly basis c. largest source of revenue for states d. five states do not have a state sales tax 1). Delaware, Alaska, Montana, New Hampshire and Oregon e. sales tax is rarely put on necessities such as food, clothing and prescription drugs STATISTICS AS OF 1995

2. Intergovernmental Revenues a. funds given to the states from the federal government for programs such as welfare, education, highways and hospitals 3. Individual State Income Tax a. like federal income tax, states also collect a tax based on income 4. Employee Retirement Contributions a. many states require people to pay a tax in order to cover the costs of retirement and pension costs of state employees 5. Other Revenues a. tuition from state run colleges and universities b. corporate income taxes

B. Local Government Revenue Sources (How do cities, and towns make $) 1. Intergovernmental Revenue a. funds given to cities and towns from the state government for programs such as education and welfare 2. Property Taxes a. different forms of property tax includes real property tax, tangible property tax, and intangible property tax b. real estate tax is the tax that raises the most revenue for towns 1). People are taxed based on the value of their home and property

3. Liquor Store Income a. taxes placed on liquor sold in stores b. creates a good amount of revenue for the government 4. Sales Taxes a. Some towns may impose their own sales tax in addition to the state sales tax 5. Other Sources of Revenue a. personal income tax (local income tax) b. Occupational Privilege Tax (PA) $10-$52

C. Examining your Paycheck 1. Federal, State, and Local taxes are taken out of your paycheck 2. Taxes not taken out of your check that must be paid separately often include property taxes and school taxes Gross bi-weekly pay Year to Date Gross Pay (no taxes taken out) 8.54 %6.2%1.45%3.07%0.09% 1%7.5%.03%12.66% Voluntary 403(b) 40.51% of pay is never seen $ for 10 days at 7.5 hours per day: $18.42 gross pay per hour - $10.96 net pay per hour + medical benefits

Federal Spending Mandatory (60%): Money that lawmakers are required by existing laws to spend on certain programs or to use for interest payments on the national debt Discretionary (40%): Spending about which government planners can make choices

Mandatory Spending About 2/3 of federal revenue is spent on interest and entitlement benefits.

Discretionary Spending About 1/3 of federal revenue is spent on discretionary spending, the largest category being defense spending.

BALANCED BUDGET: total revenue = total spending BUDGET SURPLUS: total spending total revenue Three possible budget outcomes: