This document discusses key concepts related to tax systems, including: - The objectives of an efficient tax system are to minimize costs and be equitable. - Taxes can create deadweight loss and administrative burdens, so efficiency aims to minimize these. - Taxes distort behavior and change incentives, so different types of taxes like income or consumption taxes are considered. - Fairness of taxes is debated in terms of ability to pay and benefits received from public services. Progressive, proportional and regressive tax rates are compared in terms of how rates change with income.

1. Microeconomics
Lecture 12
!
Tax Systems

2. Key Terms
average tax rate
marginal tax rate
lump-sum tax
benefits principle
ability-to-pay principle
vertical equity
horizontal equity
proportional tax
regressive tax
progressive tax

3. Tax System
Two Objectives:
Efficient and Equitable
Lower costs and fair

4. Avoid
deadweight loss
administrative burdens
!
Efficient?
low deadweight loss and low
administrative burdens

5. Efficient?
low deadweight loss
and
low administrative burdens

6. Administrative Burden
It costs time and
money to collect
taxes

7. Tax Analysis
100
Supply
with 40 SAR tax
90
80
40
Taxes
40
120 in taxes
!
40 to deadweight
loss
!
60
50
!
40
Buyer
Surplus
70
Loss of 160 in
surplus
Supply
with no tax
25 percent loss
to deadweight
Tax of 40 SAR
Seller
Surplus
30
40
20
10
0
Demand
0
1
2
3
4
5
6
7
8
9
10
Tax on Seller with shift Supply curve up by the amount of the tax

8. Incentives
taxes distort
change behavior
!

9. Type of Taxes
Income - Earn
Consumption - Spend

10. Are Taxes Fair?
Benefits
!
Ability to Pay

11. Benefits
You should pay for
the benefits you
receive
!

12. Ability
If you are able you
should pay more

13. Tradeoffs
Fair or Efficient?

14. Income Tax Rates
Lump-Sum
Proportional
Progressive
Regressive

15. Lump Sum
Pay a fixed amount
regardless of income

16. Proportional
Pay a fixed rate
regardless of income

17. Progressive
Pay an
increasing rate
as income increases

18. Regressive
Pay a
decreasing rate
as income increases

19. Rates
Average
Marginal

20. Average
total taxes
divided by
income

21. Marginal
extra tax on the
next riyal of
income

22. Marginal
10% on first 100
30% on the next 100
then 50% above

23. Tax
Rate
Income
Tax
First 100
10%
100
10
101 to 200
30%
100
30
more than 200
50%
100
50
Summary
30%
300
90
What is the average rate? 90 ÷ 300 = 30%
Total taxes divided by total income
What is the marginal rate?
50%
Rate on the next riyal

24. 100
75
50
25
0
First 100
Second 100
Third 100

25. Incentives Matter
Change the rates
!
Change behavior

26. Art
Laffer
Laffer
Curve

27. Dropped Top Marginal
Income Tax Rate
from 70% to 28%
Maximum
Revenue
$
Tax
Revenue
No
Revenue
0%
10%
20%
30%
40%
50%
60%
Tax Rate
70%
80%
90%
100%

28. Income above $200,000
Pie x 8.7
Taxes x 4.2
1980
70% Rate
$36 billion - $19 billion
Smaller slice of a larger pie
1988
28% Rate
$352 billion - $100 billion