Chapter Nine – Sources of Government Revenue

Section One – The Economics of Taxation Economic Impact of Taxes i. Total tax revenue even when adjusted for inflation has risen dramatically a. Resource Allocation i. Affects factors of production (makes the supply curve move left) ii. When prices rise some consumers choose to buy other goods, fundamentally altering some industries b. Behavior Adjustment i. Used to encourage or discourage some behavior - deduct mortgage interest - sin taxes (liquor, tobacco)

c. Productivity and Growth i. Could discourage productivity (higher income taxes) ii. At what level do productivity and growth suffer? d. The Incidence of a Tax i. The final burden of a tax - higher prices - lower wages

Criteria of Effective Taxes a. Equity i. People want them to be fair - Flat Tax or Progressive Tax? b. Simplicity i. Sales tax is much simpler than the Income Tax c. Efficiency i. Easy to administer ii. Raise enough revenue to be worthwhile

III. Two Principles of Taxation a. Benefit Principle i. Those who benefit from the governments goods and services should pay in proportion to the amount of benefits they receive (gas tax built into the price) ii. Benefits often difficult to measure iii. Those who receive the benefits are often the least able to pay b. Ability-to-Pay-Principle i. Higher taxes for people with higher incomes (Progressive Taxes) ii. The assumption is the wealthy will suffer less by paying higher taxes

Types of Taxes i. Proportional Tax – Same percentage rate on everyone ii. Progressive Tax – Higher percentage rate of taxation on people with higher incomes iii. Regressive Tax – Higher percentage rate of taxation on lower incomes - Often times based on consumption

Section Two – The Federal Tax System Individual Income Taxes a. Payroll Deductions i. Employers automatically deduct income taxes from your paycheck ii. Tax returns are due April 15th b. A Progressive Income Tax i. Average tax rate goes up as your income goes up c. Indexing i. An upward revision of tax brackets to keep workers from paying more taxes just because of inflation

II. FICA Taxes a. Social Security Taxes i. Capped at a fixed income level then regressive afterwards ii. It’s proportional until the cap b. Medicare i. Set at a flat rate and not capped

Corporate Income Taxes i. Taxes corporations pay on their profits Other Federal Taxes a. Excise Taxes i. Tax on the manufacture or sale of an item (gasoline, liquor) ii. Tend to be regressive a. Estate and Gift Taxes i. Estate Tax - tax the government levies on the transfer of a property when someone dies ii. Gift Tax – tax on the donations of money or wealth and is paid by the person who makes the gift

b. Customs Duties i. Charge levied on goods brought in from other countries ii. Congress decides what to tax and at what rate c. Miscellaneous Fees i. User Fees – Based on the benefit principle - more favorable than taxes

Section Three – State and Local Taxes State Government Revenue Sources a. Intergovernmental Revenue Sources i. Funds government receives from another level of government - federal transfers to the states - over 20% of all state revenues

b. Taxes and Fees i. Sales taxes are the 2nd largest source of revenue for states - about 20% ii. Other taxes or fees cover retirement funds and pension plans - 3rd largest source of revenue iii. Individual income taxes are the 4th largest source of state revenue

c. Other Revenues i. Earnings on surplus funds ii. Tuition and other fees collected by state funded institutions d. The Choice of Tax i. Many states run lotteries to collect funds ii. Money must be collected in one form or another

II. Local Government Revenue Sources a. Intergovernmental Revenues i. 1/3rd of their revenues from state governments - usually intended for education or welfare b. Property Taxes i. 2nd largest source of revenue ii. Determined on land value c. Other Sources i. Earnings on public utilities ii. Some cities have a separate sales tax Examining Your Paycheck i. These funds are deducted from your paycheck

Section Four – Current Tax Issues Tax Reform The Value Added Tax a. Concept of Value Added i. tax each stage of value added to a product - logger-mills-manufacturer-wholesaler-retailer b. Advantages of a VAT i. the tax is spread making it harder to shift the burden ii. Its hard to avoid and easy to collect iii. Some argue it encourages savings c. Disadvantages of a VAT i. tends to be invisible to consumers ii. It would compete with state sales taxes

III. The Flat Tax a. Advantages of a Flat Tax i. It’s simple ii. It closes tax loopholes iii. Reduces the need for tax accountants, preparers and some of the IRS b. Disadvantages of a Flat Tax i. eliminates some of the incentives already built into the tax code - mortgage deductions, charitable donations ii. May benefit people with high incomes rather than the middle class IV. The Inevitability of Future Reforms i. the income tax is very complex