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9-1: The Economics of Taxation Economic Impact of Taxes Resource allocation – when taxes are raised on a product, consumers buy less, manufacturers produce less, and resources will have to go to other industries to be employed Behavior adjustment - taxes can be used to encourage or discourage certain types of activities By changing incentives to save, invest and work, taxes affect productivity and growth
Criteria for Effective Taxes Equity - fair Simplicity – easy to understand Efficiency – benefits outweigh costs Two Principles of Taxation: Benefit Principle – belief that taxes should be paid based on benefits received, regardless of income Ability to Pay Principle – belief that taxes should be paid according to the level of income, regardless of benefits received
Three Types of Taxes 1. Proportional Tax – as income goes up, the percentage of income paid in taxes stays the same 2, Progressive Tax – as income goes up, the percentage of income paid in taxes goes up 3. Regressive Tax - as income goes up, the percentage of income paid in taxes goes down
9-2: Federal, State, and Local Revenue Systems Federal Government Revenue Sources (in order of size) 1. Individual Income Taxes – collected with a payroll withholding system that automatically deducts income taxes from paychecks 2. FICA Taxes - Federal Insurance Contributions Act - tax levied on employers and employees to support Social Security and Medicare - also automatically deducted from paycheck 3. Borrowing 4. Corporate Income Taxes 5. Excise Taxes – tax on manufacture or sell of selected items such as gasoline and liquor
6. Estate and Gift Taxes 7. Customs Duties 8. Miscellaneous Fees
State Government Revenue Sources (in order of size) 1. Intergovernmental Revenues – funds collected by one level of government that is distributed to another level of government for expenditures 2. Sales Taxes - general tax levied on consumer goods - 5 states do not have a general sales tax 3. Individual Income Taxes - only 7 states do not rely on individual income taxes for revenue - varies widely from state to state 4. Other Revenues - interest earnings - tuition and fees - corporate income taxes
Local Government Revenue Sources (in order of size) 1. Intergovernmental Revenues 2. Property Taxes - tax on tangible and intangible possessions such as real estate, buildings, furniture, stocks, bonds and bank accounts 3. Utility Revenues - public utility companies that supply water, electricity, sewer, and sometimes telecommunications are often owned by local governments 4. Sales Taxes 5. Other Revenue Sources - interest earnings - fees - borrowing
9-3: Current Tax Issues and Reforms Current Tax Code is incredibly complex Tax Reform: 1981 Economic Recovery Tax Act included large tax deductions for individuals and businesses, accelerated depreciation, and investment tax credits Tax Reform: 1986 Tax Reform: 1993 Tax Reform: 1997 Tax Reform: 2001 Tax Reform: 2003 Permanent tax cuts by 2011?
Alternative Tax Approaches Flat Tax – a proportional tax on individual income Simple Closes “loopholes” Save $$ and time preparing tax returns Removes incentives in current tax code Value-Added Tax – Tax consumption, not income Equivalent to a national sales tax Tax on the value added at every stage of the production process