The Tax System  Most people agree that taxes should impose as small a cost on society as possible.  The tax system should be efficient and equitable.

Taxes and Equity Criteria  Benefits principle  Ability-to-pay principle

Benefits Principle  The benefits principle is the idea that people should pay taxes based on the benefits they receive from government services.  An example is a gasoline tax: ä Tax revenues from a gasoline tax are used to finance our highway system. ä People who drive the most also pay themost toward maintaining roads.

Ability-to-Pay Principle  The ability-to-pay principle is the idea that taxes should be levied according to an individual’s ability to shoulder the tax burden.  The ability-to-pay principle leads to two corollary notions of equity. ä Vertical equity ä Horizontal equity

Paying for the Public Sector  Marginal Tax Rate The tax rate on the last dollars earned  Average Tax Rate The proportion of total income paid in taxes

Paying for the Public Sector  Tax Bracket A specified level of taxable income to which a specific and unique marginal tax rate is applied Marginal Tax Rate = change in taxes due change in taxable income

Paying for the Public Sector  Taxation systems Progressive Taxation  Marginal tax rate > Average tax rate  As a person’s taxable income increases, the percentage of income paid in taxes increases

Progressive Taxation: Income Tax Taxable Income Tax Rate Tax Liability 0–$10,000 5%$500 $10,001–20,000 10%$1,000 $20,001–30,000 30%$3,000 $4,500 Income = $30,000 Marginal Tax Rate = 30% Average Tax Rate = 15% or $4,500/$30,000

Federal Corporate Income Tax Schedule $0–$50,00015% $50,001–75,00025% $75,001–10,000,00034% $10,000,001 and up35% Progressive Taxation: Income Tax Corporate Taxable IncomeCorporate Tax Rate Source: U.S. Department of Treasury

The Most Important Federal Taxes  The corporate income tax Accounts for 12% of all federal revenue  The federal personal income tax Accounts for 46% of all federal revenue

Federal Income Tax Rates: Schedule X — Single If taxable income is over-- But not over-- The tax is: $0$7,82510% of the amount over $0 $7,825$31,850 $ plus 15% of the amount over 7,825 $31,850$77,100 $4, plus 25% of the amount over 31,850 $77,100$160,850 $15, plus 28% of the amount over 77,100 $160,850$349,700 $39, plus 33% of the amount over 160,850 $349,700no limit $101, plus 35% of the amount over 349,700

Paying for the Public Sector  Taxation systems Proportional Taxation (flat-rate tax)  Marginal tax rate = Average tax rate  Everyone pays the same percentage of their income in taxes

Proportional Taxation Proportional Tax Rate = 20% Taxable Income x Tax Rate = Tax Liability $10,00020%$2,000 $100,00020%$20,000 Marginal Tax Rate = 20% Average Tax Rate = 20%

Paying for the Public Sector  Taxation systems Regressive Taxation  Marginal tax rate < Average tax rate  As a person’s taxable income increases, the percentage of income paid in taxes decreases

Regressive Taxation Taxable Income Tax Rate* Tax Liability $5,00010%$500 $100,000———$5,000 *Tax Rate = 10% on first $50,000 of income; no tax on add. income Income = $5,000 Marginal Tax Rate and Average Tax Rate = 10% Income = $100,000 Marginal Tax Rate = 0% Average Tax Rate = 5% or $5,000/$100,000

Taxes and Equity  How should the burden of taxes be divided among the population?  How do we evaluate whether a tax system is fair?

Tax Incidence and Equity  The difficulty in formulating tax policy is balancing the often conflicting goals of efficiency and equity.  The study of who bears the burden of taxes is central to evaluating tax equity.  This study is called tax incidence.

Lorenz Curve Shows the degree of inequality that exists in the distributions of two variables, and is often used to illustrate the extent that income or wealth are distributed unequally in a particular society.

Laffer Curve

Conclusion  A proportional tax is one for which high- income and low-income taxpayers pay the same fraction of income.

Conclusion  A regressive tax is one for which high-income taxpayers pay a smaller fraction of their income than do low-income taxpayers.

Conclusion  A progressive tax is one for which high- income taxpayers pay a larger fraction of their income than do low-income taxpayers.

Conclusion  The U.S. government raises revenue using various taxes. ä Income taxes and payroll taxes raise the most revenue for the federal government. ä Sales taxes and property taxes raise the most revenue for the state governments.

Conclusion  Equity and efficiency are the two most important goals of the tax system.  A tax system is said to be more efficient if it raises the same amount of revenue at a smaller cost to taxpayers.

Conclusion  Many proposed changes in the tax laws increase efficiency while reducing equity, or increase equity while reducing efficiency.  Debates over tax policy arise because people value these two goals differently.

The next four questions refer to the below supply and demand graph for a product on which the government imposes an excise tax. (a) What is the amount of the tax per unit? (b) What is the total amount of the excise tax paid by the consumer? By the producer? (c) What is the total tax revenue for government? (d) What is the efficiency loss of the tax?

Answer the next two questions on the basis of the following demand and supply data for a competitive market:Quantity demandedPricesupplied 3,000 $77,000 4,00066,000 5,00055,000 6,00044,000 7,00033,000 (a) If government levies a per unit excise tax of $2 on suppliers of this product, what would the equilibrium price and quantity be? How much tax will be paid? (b) If government has instead provided a per unit subsidy of $2 to suppliers of this product, what would the equilibrium price and quantity be?