PPT Ch 6

Report
Chapter 6
Funding the
Public Sector
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Introduction
During his presidential campaign, Barack Obama
stated that he would consider doubling the top tax
rate on capital gains.
Shortly after taking office, he proposed raising the top
tax rate on capital gains by only one-third.
Are there any practical limitations on how high
governments can raise tax rates in hopes of obtaining
more tax revenues?
This chapter helps you understand the relationship
between tax rates and tax revenues.
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6-2
Learning Objectives
• Distinguish between average tax rates and
marginal tax rates
• Explain the structure of the U.S. income
tax system
• Understand the key factors influencing the
relationship between tax rates and the tax
revenues governments collect
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Learning Objectives (cont'd)
• Explain how the taxes governments levy
on purchases of goods and services affect
market prices and equilibrium quantities
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Chapter Outline
•
•
•
•
•
Paying for the Public Sector
Systems of Taxation
The Most Important Federal Taxes
Tax Rates and Tax Revenues
Taxation from the Point of View of
Producers and Consumers
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6-5
Did You Know That ...
• The body of laws and rules governing the
assessment and collection of U.S. federal taxes
expands at an average rate of 1,000 words per
day?
• To obtain the funds required to finance their
operations, governments collect taxes from many
different sources (property tax, sales tax, income
tax, etc), hence the multitude of words written
into a variety of statutes governing taxation.
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Paying for the Public Sector
• Three sources of government funding
1. Fees for government services, or user charges
2. Taxes
3. Borrowing
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Paying for the Public Sector (cont'd)
• Government Budget Constraint
– The limit on government spending and transfer
payments
– Imposed by the fact that every dollar spent
must be provided for by taxes
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Policy Example: Government Grinches Grab
Gifts!
• During the Great Recession of the late 2000s,
declines in incomes and spending resulted in sharp
declines in income and sale taxes to U.S. state
governments.
• To help raise government revenues, nearly half of
U.S. states now impound unused balances on gift
cards as user charges.
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Systems of Taxation
• Tax Base
– The value of goods, services, wealth, or
incomes subject to taxation
• Tax Rate
– The proportion of a tax base that must be paid
to a government as taxes
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6-10
Policy Example: Will U.S. Consumers Pour
Their Dollars into a Federal VAT?
• U.S. States have levied sales taxes by applying
tax rates to the dollar amounts that businesses
receive on sales of goods and services.
• Recently, congressional leaders have suggested a
new federal value-added tax (VAT), which are
applied to every stage of an item’s production, so
that the final price that a consumer pays would
reflect the various federal VAT rates imposed
during a good’s production.
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Systems of Taxation (cont'd)
• Marginal Tax Rate
– The change in the tax payment divided by the
change in income
change in taxes due
Marginal tax rate =
change in taxable income
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Systems of Taxation (cont'd)
• Tax Bracket
– A specified interval of income to which a
specific and unique marginal tax rate is applied
• Average Tax Rate
– The total tax payment divided by total income
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Policy Example: What the Typical Taxpayer
Owes Out of the Next Dollar Earned
• Economists Robert Barro and Charles Redlick have
calculated the marginal tax rate faced by an
average U.S. resident.
• In 1920, the marginal income tax rate in the
United States was just below 5 percent on
average.
• Today, the marginal income tax rate, which
includes the rates for federal income tax, state
income tax and Social Security and Medicare
income taxes, is nearly 36 percent.
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Systems of Taxation (cont'd)
• Proportional Taxation
– A tax system in which, regardless of an
individual’s income, the tax bill comprises
exactly the same proportion
– Taxpayers at all income levels pay the same
percentage of their income in taxes
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Systems of Taxation (cont'd)
Proportional taxation
Marginal tax rate = Average tax rate
Income
$10,000
$100,000
Tax Rate
20%
20%
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Taxes
$2,000
$20,000
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Systems of Taxation (cont'd)
• Progressive Taxation
– A tax system in which, as income increases, a
higher percentage of the additional income is
paid as taxes
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Systems of Taxation (cont'd)
Progressive taxation
Marginal tax rate > Average tax rate
Income
$0–$10,000
$10,001–$20,000
$20,001–$30,000
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Tax Rate Taxes
5%
$500
10%
$1,000
30%
$3,000
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Systems of Taxation (cont'd)
• Regressive Taxation
– A tax system in which as more dollars are
earned, the percentage of tax paid on them
falls
– A smaller percentage of income is taken in
taxes as income increases
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Systems of Taxation (cont'd)
Regressive taxation: Social Security*
Marginal tax rate < Average tax rate
Income
$100,000
$200,000
Tax Rate
10%
5%
Taxes
$10,000
$10,000
* No social security tax after $100,000 in income
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The Most Important Federal Taxes
• Question
– What types of taxes do federal, state and local
governments collect?
• Answers
– Federal government: individual income taxes,
corporate income taxes, Social Security taxes,
import and excise taxes
– State and local governments: sales taxes,
property taxes, personal and corporate income
taxes
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Figure 6-1 Sources of Government Tax
Receipts
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The Most Important Federal Taxes
• The federal personal income tax
– Accounts for almost 44% of all federal revenue
– All U.S. citizens, resident aliens, and most
others required to pay (includes income earned
abroad)
– Rates paid rise as income increases
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Table 6-1 Federal Marginal Income Tax
Rates
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The Most Important Federal Taxes
(cont'd)
• Arguments for the progressive tax
– Redistribution of income
– Ability to pay
– Benefits received
• Counterargument
– No strong evidence of redistribution
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The Most Important Federal Taxes
(cont'd)
• Capital Gain
– The positive difference between the purchase
price and the sale price of an asset
• You buy a share of stock for $5 and sell for $15: you
have a capital gain of $10
• Capital Loss
– The negative difference between the purchase
price and the sale price of an asset
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The Most Important Federal Taxes
(cont'd)
• The corporate income tax
– Accounts for 12% of federal tax revenue and
2% of all state and local taxes collected
– Corporations are generally taxed on the
difference between total revenues and
expenses
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Table 6-2 Federal Corporate Income
Tax Schedule
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The Most Important Federal Taxes
(cont'd)
• Double taxation
– Corporation pays taxes on its profits
– Corporation declares a dividend on after-tax
profits
– Dividend income is taxed
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The Most Important Federal Taxes
(cont'd)
• Retained Earnings
– Earnings that a corporation saves, or retains,
for investment in other productive activities
– Earnings that are not distributed to
stockholders
• Tax Incidence
– The distribution of tax burdens among various
groups in society
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6-30
The Most Important Federal Taxes
(cont'd)
• Who really pays the corporate income tax?
– Tax incidence is distributed among
• Consumers
• Stockholders
• Employees
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The Most Important Federal Taxes
(cont'd)
• Social Security taxes
– Social Security rates today are imposed on
earnings up to roughly $106,800
– Contributions are 6.2% for employers and
6.2% for employees
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The Most Important Federal Taxes
(cont'd)
• Unemployment taxes
– Paid by employer
– 0.8% of first $7,000 of wages for employees
earning more than $1,500
– States may levy an additional tax up to 3%
based on record of the employer
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Tax Rates and Tax Revenues
• State and local governments
– Taxes imposed on goods and services yield
more revenues than income taxes
– A fundamental issue is how to set tax rates to
extract the largest possible payments
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Tax Rates and Tax Revenues
(cont'd)
• Sales Taxes
– Taxes assessed on the prices paid on a large
set of goods and services
• Ad Valorem Taxation
– Assessing taxes by charging a tax rate equal to
a fraction of the market price of each unit
purchased
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Tax Rates and Tax Revenues
(cont'd)
• Static Tax Analysis
– Based on the assumption that changes in the
tax rate leave the tax base unaffected
• Dynamic Tax Analysis
– Recognizes that higher tax rates may shrink
the tax base
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Tax Rates and Tax Revenues
(cont'd)
• If the disincentive effects of higher tax rates are
small, static analysis may give a fairly accurate
estimate of the change in tax revenues resulting
from a tax rate change
• As tax rates escalate, members of the public have
a greater incentive to remove their activities from
the tax base; a dynamic analysis would be
necessary to determine the overall effect on
government revenues
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Figure 6-2 States with the Highest and
Lowest Sales Tax Rates
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Why Not … follow the example of states such as Maryland
by creating a “millionaires” tax bracket with extra-high
tax rates applied to incomes exceeding $1 million per
year?
• The year after Maryland established a special
millionaires tax bracket with a combined state
and city tax rate of almost 10 percent, more than
one-third of all the millionaires—people with
annual incomes exceeding $1 million—responded
by switching their formal residences to other
lower-tax states, such as Florida and South
Carolina.
• As a result, Maryland received almost $100
million per year less in taxes from millionaires.
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International Policy Example: Ireland Collects
Plenty of Corporate Taxes with a Low Rate
• Ireland’s corporate profits tax is only 12.5
percent, as compared to nearly 40 percent for the
United States.
• The nation’s lower corporate profits tax rates
boosted corporate profits and consequently tax
revenues.
• During the 2000s, the Irish government collected
an amount of corporate profits taxes equal to 3.6
percent of Ireland’s national income, while
corporate profits taxes in the United States were
2.1 percent of U.S. annual income.
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Tax Rates and Tax Revenues
(cont'd)
• Maximizing tax revenues
– Dynamic tax analysis predicts ever-higher tax
rates bring about declines in the tax base
– At sufficiently high rates the government’s tax
revenues begin to fall off
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Figure 6-3 Maximizing the Government’s
Sales Tax Revenues
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Taxation from the Point of View of
Producers and Consumers
• Excise Tax
– A tax levied on purchases of a particular good
or service
• Unit Tax
– A constant tax assessed on each unit of a good
that consumers purchase
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Taxation from the Point of View of
Producers and Consumers (cont'd)
• Excise taxes on gasoline become added
costs of production
• This shifts the supply curve up by the
amount of the unit tax
• Consequently, the equilibrium price of
gasoline rises and the equilibrium quantity
declines
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Figure 6-4 The Effects of Excise Taxes on the Market
Supply and Equilibrium Price and Quantity of Gasoline
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Taxation from the Point of View of
Producers and Consumers (cont'd)
• Who Pays the Tax?
– In our example, the price that each consumer
pays is $0.30 per gallon higher
– Therefore, consumers pay three-fourths of the
excise tax and producers absorb the remainder
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You Are There: A Business Owner Responds to a
Marginal Tax Rate Increase
• A Utah physician, Wendell Gibby, M.D., owns a
small company that produces medical imaging
software.
• In response to an increase in his marginal income
tax rate from about 40 percent to well over 50
percent, he reduces his production and cuts a few
jobs in his company.
• The reductions in sales and thus Dr. Gibby’s
income also mean less income for the
government to tax.
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Issues & Applications: Raising Capital Gains Tax
Rates Shrinks the Tax Base
• Policymakers pressing for a higher tax rate on
capital gains in order to generate more tax
revenues rely on static tax analysis.
• But according to dynamic tax analysis, higher tax
rates on capital gains may induce people not to
realize these gains, thereby shrinking the capital
gains tax base.
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Figure 6-5 Capital Gains Tax Rates and Realized
Capital Gains as a Percentage of Aggregate U.S.
National Income
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Summary Discussion of Learning
Objectives
• Average tax rates versus marginal tax
rates
– Average tax rate is the ratio of total tax
payments to total income
– Marginal tax rate is the change in tax
payments, induced by a change in total taxable
income: applies to the last dollar earned
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6-50
Summary Discussion of Learning
Objectives (cont'd)
• The U.S. income tax system taxes personal and
business income
– A tax system is progressive when marginal tax rate
increases as income rises
– Contrasts with regressive system, in which higherincome earners pay lower marginal tax rates
– Under proportional taxation, the marginal and average
rate are equal
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Summary Discussion of Learning
Objectives (cont'd)
• The relationship between tax rates and tax
revenues
– Static tax analysis assumes that the tax base
does not respond significantly to an increase in
the tax rate
– Dynamic tax analysis reveals how an increase
in the tax rate causes the tax base to decline
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Summary Discussion of Learning
Objectives (cont'd)
• How taxes on purchases of goods and
services affect market prices and
quantities
– A tax collected from the seller of a good will
shift the supply curve up
– To the extent that the price rises, consumers
pay a portion of the tax and sellers pay the
remainder
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