more on taxation
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More on taxation. Today: More on efficiency and equitability; An introduction to the US personal income tax. Today. More on taxation What should be taxed in order to gain efficiency? Tax evasion versus tax avoidance Underground economies An introduction to the US personal income tax - PowerPoint PPT PresentationTRANSCRIPT
More on taxation
Today: More on efficiency and equitability; An introduction to the US personal income tax
Today
More on taxation What should be taxed in order to gain efficiency? Tax evasion versus tax avoidance
Underground economies An introduction to the US personal income tax
Defining income Money value Income used for tax purposes
Computation of tax liability Exemptions, deductions, credits, marginal tax rates,
inflation, the alternative minimum tax
Recall from last lecture
Taxes will sometimes change behavior so much that total taxes collected may actually go down Example: Yacht tax in the early 1990s
Tax on yachts over $100,000 purchased in the US People bought yachts in other countries Net economic impact
$16.6 million in taxes collected (less than the $31 million predicted)
Less income tax paid by workers (7,600 jobs lost in the US)
Efficient taxation/tax dodging Although the yacht tax was likely
implemented to be “equitable,” efficiency suffered on all margins Excess burden due to the tax Decreased overall tax revenue collected due to
jobs lost in the US What kinds of taxes lead to less excess
burden?
Efficient taxation
Assume that the amount of tax revenue collected is set at a constant level
Should everything be taxed at the same rate in order to make the most efficient outcome? Taxing each good at the same rate is known as
neutral taxation See Figure 16.1, p. 355
Marginal excess burden
The Ramsey rule
How do we tax to reduce excess burden? Ramsey rule
Percentage reduction in quantity demanded for every good is the same
Back to our old question: Should everything be taxed at the same rate in order to make the most efficient outcome? NO
One other concept to keep in mind Marginal excess burden generally increases as the tax
increases
Equity concerns
From the Ramsey rule, inelastic goods should be taxed at higher rates in order to gain efficiency Coffee Theater/opera Salt Many prescription drugs
Example: Insulin needed to live
Should we look at fairness, too? Many people believe that fairness is just as
important as efficiency This type of person would…
Probably not want to tax insulin Impose a higher tax on goods that high-income
consume more Not want to impose a lump sum tax
Tax evasion/tax avoidance
Tax evasion Not paying taxes that are legally owed to a
government Tax avoidance
Altering behavior to legally pay less in taxes
Examples of tax avoidance
Recall yacht tax in the early 1990s Tax on yachts over $100,000 purchased in the US Tax avoidance: People bought yachts in other countries Net economic impact in the US was negative
18th century tax in Brazil Tax on finished churches Tax avoidance: Build churches that were complete except
for some trivial part that was not built See bottom picture on p. 371
This church is not “finished” since it is missing one of its towers
Tax evasion theory
Marginal benefit of cheating on taxes is constant $1 for each dollar in taxes avoided
Marginal cost is increasing Probability of getting caught cheating increases as the
number of “red flags” increases If MB > MC for some people (for the first dollar in tax
evasion), an underground economy develops See Figures 16.5 and 16.6, p. 373 and 374,
respectively Figure 16.5: Tax evasion is positive Figure 16.6: Tax evasion is zero
Summary: Efficient taxation/tax dodging Efficient taxation comes from the Ramsey
rule Percentage reduction in quantity demanded for
every good is the same Equity concerns are important in many
people’s minds Tax evasion and tax avoidance are used to
lower the amount of taxes a person pays Note that tax evasion is illegal
The US Personal Income Tax About 45% of federal revenues are generated
through personal income taxes Federal taxes are easy and simple to
understand, right? See Figure 17.1, p. 381 for the answer
Digesting federal income tax liability Tax Base- “Above-the-line” deductions
Adjusted Gross Income
- Exemptions- Larger of standard deduction or itemized deductions
Taxable Income• tax rate
Tax liability before credits- Tax credits
Regular tax liability
Wages and compensation, interest, dividends, capital gain (or loss), business income (or
loss), pensions, farm income (or loss), rents, royalties, Social
Security benefits, etc.
Trade or business expenses, moving expenses, educator
expenses, self-employed health insurance premium
payments, student loan payments, tuition and fees,
alimony paid, etc.
Phase-out with income
Charitable contributions, home mortgage interest, state and
local taxes, medical expenses in excess of 7.5% of AGI,
casualty and theft losses, non-reimbursed employee
expenses; Phase out with income; Differs by filing status
Six ordinary rates (10%, 15%, 25%, 28%, 33%, 35%);
differs by filing status; special
rates for dividends and capital gains
Child tax, additional child tax, EITC, HOPE and Lifetime Learning,
electric vehicles, health coverage tax, adoption, mortgage interest, retirement savings contribution, child and dependent care credit,
credit for the elderly or the disabled, D.C. First-Time
homebuyer’s credit, etc.; Phase-out with income
Start over to determine AMT tax liability using AMT base. Pay tentative AMT liability in excess of regular tax liability
Pay tax or claim refund
How should income be defined? Haig-Simons definition of income
“Money value of the net increase in an individual’s power to consume during a period” (R/G p. 382)
Besides traditional income, what should be counted according to this definition? Pension contributions, insurance purchases, and in-kind
benefits given by an employer Any monetary or in-kind transfer from the government Capital gains
Is all Haig-Simons income taxed? No
Interest on state and local bonds Legal issues? Makes these bonds more attractive
Unrealized capital gains Leads to “lock-in” effect
People tend to hold on to assets longer than optimal to avoid paying taxes on the gains
Pension and some retirement contributions (until benefits are received)
Education Savings Accounts
Other features of the US tax system Exemptions
$3,300 per family member is 2006 Deductions
Standard deduction $5,150 per single filer in 2006 $10,300 per joint filer in 2006 Fixed amount, no documentation needed
Itemized deductions Unreimbursed medical expenses above 7.5% of AGI State and local income and property Taxes Certain interest expenses Charitable contributions
More on simplicity
The Tax Reform Act of 1986 (TRA86) tried to simplify the tax system Increased standard deduction
Fewer people needed to itemize deductions Personal exemption increased substantially Fewer
people needed to file tax returns
Since 1986 Tax laws became more complicated About 15,000 changes to the tax code
More on simplicity
Is the tax code too complex? Some support a flat income tax
Same tax rate to everyone and each component of income
No deductions Little room for personal exemptions and business
expenses Criticism of flat income tax
Move tax burden from rich to middle class
Marginal tax rates
Official Statutory Tax Rate Schedule (2006)
Single Returns Joint ReturnsTaxable Income Marginal
Tax RateTaxable Income Marginal
Tax Rate
$0-$7,550 10% $0-$15,100 10%
$7,550-$30,650 15 $15,100-$61,300 15
$30,650-$74,200 25 $61,300-$123,700 25
$74,200-$154,800 28 $123,700-$188,450 28
$154,800-$336,550 33 $188,450-$336,550 33
$336,550 and over 35 $336,550 and over 35
Source: http://www.irs.gov/formspubs/article/0,,id=150856,00.html
Marginal tax rates
Official Statutory Tax Rate Schedule (2007)
Single Returns Joint ReturnsTaxable Income Marginal
Tax RateTaxable Income Marginal
Tax Rate
$0-$7,825 10% $0-$15,650 10%
$7,825-$31,850 15 $15,650-$63,700 15
$31,850-$77,100 25 $63,700-$128,500 25
$77,100-$160,850 28 $128,500-$195,850 28
$160,850-$349,700 33 $195,850-$349,700 33
$349,700 and over 35 $349,700 and over 35
Source: http://www.irs.gov/formspubs/article/0,,id=164272,00.html
Inflation issues
Notice that the ranges on the marginal tax rate tables increase from year to year About 3.5-4% from 2006-2007 tax years Increases account for inflation
Taxes are on real income, so to speak
Alternative minimum tax (AMT) Not adjusted for inflation More Americans are
subject to the AMT each year Under current law, 28.5 million taxpayers
expected to be subject to AMT in 2015
Summary: The US Personal Income Tax The US Personal Income Tax system is
notoriously complex Most of Haig-Simons income is counted, but not
all Exemptions and deductions lower the tax
burden on Americans Marginal tax rates increase as income
increases