Section 3.6

I.B. Economics

Taxation

Descriptive Overview:

• Students will describe the most common types of taxes levied by the government.

• Students will also be expected to identify specific taxes that fall into the major tax types

Descriptive Overview:

Students will:

identify specific tax types that fall into major tax types

explain the purpose of taxes

Key Questions

How does the government acquire money to operate on a federal, state and local level?

What are the 3 major types of taxes? How are they different?

Why is the government allowed to collect taxes?

Terminology/Vocabulary

regressive taxprogressive taxproportional tax

Regressive Taxes Defined as a tax that takes a larger share from higher incomes.

Regressive taxes do not follow the ability to pay principal. That is, people

who make more money should pay more taxes.

Sales tax is an example of a regressive tax. Some consumers may pay a

higher percentage of tax compared to individuals that earn more money.

Social Security tax is another example of a regressive tax. Residents that

make less money will pay a higher percentage of their income toward

Social Security.

Regressive tax based on percentage of income is higher in lower income

individuals.

Regressive Tax

• Max Minnie• Before-tax Income $200,000 $10,000

•Sales Tax on $1000 7% 7%

•Taxes Paid $70 $70•

•Percentage of Income.035% .7%

Social Security Tax

• In 2005, the social security tax generated about 37% of federal tax revenues.

• The social security tax is a regressive tax.

• The tax rate is the same (15.3%) for earned income up to a certain level ($94,200 in 2006). Above this income level, the rate drops to 2.9%

• Taxpayer A Taxpayer B Taxpayer C

• Earned Income $40,000 $400,000 $4,000,000

• Social security tax paid $6,120 $23,281 $127,681

• Social security tax as a percentage of Income 15.3% 5.8% 3.2%

Social Security Tax

Corporate Income Tax

• In 2005, the corporate income tax generated about 13% of all federal tax revenues.

• The corporate income tax is probably regressive in the long run.

History of the Personal Income Tax

• The 16th Amendment gave the federal government the authority to impose a personal income tax.

• The initial personal income tax was a very minor burden.

• The federal personal income tax is much more burdensome today.

Federal Income Tax Rate Schedule,Single Taxpayer, 2006

• Taxable Income Tax Rate

• $0 – $7,550 10%

• 7,550 – 30,650 15%

• 30,650 – 74,200 25%

• 74,200 – 154,800 28%

• 154,800 – 336,550 33%

• over 336,550 35%

Characteristics of a Good Tax

• Taxation imposes a burden on the taxpayers while providing funding for the government.

• Excess burden – the amount that the burden imposed by a tax exceeds the funding provided by the tax.

• A good tax is one that imposes as little excess burden as possible.

Federal Personal Income Tax

• The federal personal income tax imposes a large excess burden because:

• 1. It is extremely complicated.

• 2. It imposes a large deadweight loss due to;

• a. the presence of numerous loopholes.

• b. the relatively high tax rates.

To Make the Federal Income Tax a Better Tax:

• Make it simpler. Eliminating the loopholes would reduce the collection cost and the compliance cost of the tax and stop the distortion of private market decisions caused by the loopholes.

• Eliminating the loopholes would also broaden the tax base, allowing the same amount of revenue to be collected with lower tax rates.

Major Federal Spending Programs - 2005

• 1. Social security. ($522 billion)

• 2. National defense. ($493 billion)

• 3. Income security. ($349 billion)

• 4. Medicare. ($295 billion)

• 5. Health (including Medicaid). ($256 billion)

• 6. Interest on the National Debt. ($183 billion)

Deficits and the National Debt

• A budget deficit occurs when government expenditures exceed tax revenues.

• For most of the last seventy years, the federal budget has had deficits.

• Years of budget deficits have led to an enormous national debt.

• National debt – the total amount the federal government owes its creditors.

Progressive Taxes

Progressive taxes are based on the ability to pay principal.

Taxpayers at higher income levels pay larger proportions

of their incomes in taxes than people at lower levels.

Federal income tax is based on a progressive tax.

The more money individuals make the more money they

are asked to pay in taxes.

Progressive Tax

• Max Minnie• Before-tax Income $200,000 $10,000

•Tax Rate 30% 10%

•Taxes Paid $60,000 $1,000

•After-tax Income $140,000 $9,000

Proportional Taxes

A proportional tax is one that imposes the same percentage rate of taxation on everyone’s income.

Based on the thought, the higher the value, the greater the tax bill.

An example would be a school tax of 2.5% for all residents.

Proportional taxes do follow the ability to pay principal.

Proportional Tax

• Max Minnie• Before-tax Income $200,000 $10,000

• Tax Rate 20% 20%

• Taxes Paid $40,000 $2,000

• After-tax Income $160,000 $8,000

Types of Taxes

• Direct tax-a tax paid by the person against whom the tax is levied

• Indirect tax-a tax that can be shifted to a party other than one on whom the tax is levied

• Sales tax-a tax on goods that are bought and sold

• Excise tax- a sales tax levied only on specific items

The Purpose of Taxes

Taxes raise money to finance government programs and services. Taxes regulate or restrict certain types of business practices,

products or services. Income, sales, estate and gift and property taxes are revenue taxes. Excise taxes and import duties are regulatory taxes. Taxes raise money to finance government programs and services. Taxes regulate or restrict certain types of business practices,

products or services. Income, sales, estate and gift and property taxes are revenue taxes. Excise taxes and import duties are regulatory taxes.

Ability-to-pay principal

The ability-to-pay principal states that taxes should be paid by citizens who can most afford them. This should be regardless of any benefits they receive. Economists argue that although taxes may not enable some high-income groups certain luxuries, taxation hinders lower income individuals from gaining necessities.