1. Consumption and Income Taxes
MPA 622: Government Finance

2. Principles of Sound Tax Policy
Adequacy
Neutrality
Fair or equitable
Horizontal
Vertical
Ease of Administration and Compliance
Accountability
Administration and enforcement should be efficient and fair
Government must enforce the laws
Open, transparent tax policy

3. Haig-Simons Definition of Income
Annual changes in the ability to consume
Present consumption
Future consumption

4. Income Tax and Savings Savings rate in the United States Income Effect
Substitution Effect
Increase in income tax rates
Decrease in income tax rates
Effect on savings

6. Two Period Consumption and Saving
Two period model
Consume now
Save and consume later
Choice
Normal goods
Increase in income means you will increase present and future consumption
Decrease in income means you will decrease present and future consumption
Income Effect
Increase in the price of a good causes us to decrease consumption of that good and increase the consumption of the alternative
Decrease in the price of a good causes us to increase consumption of that good and decrease the consumption of the alternative
Substitution Effect

7. Interest Rate Example Budget: $1,000 Interest Rate: 10% $500 Now
$550 Future
Consumption Possibilities I
$400 Now
$660 Future
Consumption Possibilities II
$600 Now
$440 Future
Consumption Possibilities III

8. Effect of Increase in Interest Rates
$500 Present Consumption
$550 Future Consumption
20% Interest Rate
$600 Future Consumption
$510 Present Consumption
$588 Future Consumption

9. Effect of Increase in Interest Rates
More future income because of higher interest rates
Substitution effect: save more (decrease current consumption) because the opportunity cost of current consumption has increased
Income effect: save less (increase current consumption) still have enough income for more future consumption

10. Effect of Decrease in Interest Rates
$500 Present Consumption
$550 Future Consumption
5% Interest Rate
$525 Future Consumption
$480 Present Consumption
$546 Future Consumption

11. Effect of Decrease in Interest Rates
Less future income because of lower interest rates
Substitution effect: save less (increase current consumption) because the opportunity cost of current consumption has decreased
Income effect: save more (decrease current consumption) in order to make up for the decrease in future consumption

12. After Tax Interest Rate

13. Effect of Decrease in Income Tax Rate or Increase in After Tax Interest Rates
More future income because of higher after tax interest rates
Substitution effect: save more (decrease current consumption) because the opportunity cost of current consumption has increased
Income effect: save less (increase current consumption) still have enough income for more future consumption

14. Effect of Incease in Income Tax Rate or Decrease in After Tax Interest Rates
Less future income because of lower after tax interest rates
Substitution effect: save less (increase current consumption) because the opportunity cost of current consumption has decreased
Income effect: save more (decrease current consumption) in order to make up for the decrease in future consumption

15. Hall-Rabushka Flat Tax
Single tax rate on labor income 01
Subtraction method VAT tax 02
Exempts all capital income 03
Fairness? 04
Middle class impact 05
Hall-Rabushka Flat Tax

16. David Bradford’s X-Tax
Hall-Rabuska Proposal
Graduated Rates
David Bradford’s X-Tax

17. Savings is complete exempted from taxation
Consumed Income Tax
Savings is complete exempted from taxation
We either consume or save our income

18. Savings Plans 401k savings plans Automatic enrollment
Traditional IRA’s
Roth IRA’s
Relationship to consumed income tax

19. Effectiveness in Encouraging Savings
Empirical evidence suggests that people aren’t sensitive to rate of saving
Current consumption and future consumption
Income Effect
Substitution Effect