Premium CH 12 The Design of The Tax System

N.
GREGORY MANKIW
PRINCIPLES OF
ECONOMICS
Eight Edition
CHAPTER
The Design of
12 the Tax System
Premium PowerPoint Slides by:
V. Andreea CHIRITESCU
Eastern Illinois University
© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use
as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning
1
management system for classroom use.
Look for the answers to these questions:
• What are the largest sources of tax revenue
in the U.S.?
• What are the efficiency costs of taxes?
• How can we evaluate the equity of a tax
system?
as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning 2
Introduction
• ‘A government can sometimes improve
market outcomes’
– Providing public goods
– Regulating the use of common resources
– Remedying the effects of externalities
• The government
– Raises revenue through taxation
– To perform its many functions
Introduction
• Lessons about taxes from earlier
chapters:
– A tax on a good reduces the market
quantity of that good.
– The burden of a tax is shared between
buyers and sellers depending on the price
elasticities of demand and supply.
– A tax causes a deadweight loss.
Government Revenue as a Percentage of GDP:
Changes over Time
This figure shows revenue of the
federal government and of state
and local governments as a
percentage of gross domestic
product (GDP), which measures
total income in the economy. It
shows that the government plays a
large role in the U.S. economy and
that its role has grown over time.
An Overview of U.S. Taxation
• Government revenue - increased
– As percentage of total income
– As economy’s income has grown
• Government’s revenue from taxation has
grown even more
• As a nation gets richer
– Government - takes a larger share of
income in taxes
Government Revenue as a Percentage of GDP:
International Comparisons
Receipts of the Federal Government: 2016 Q1
Amount Amount Percent

(billions) per person of receipts
Personal current taxes $1,572.8 $4,865.3 45.0%
Social insurance 1,224.1 3,786.6 35.1
Taxes on corporate income 410.6 1270.2 11.8
Others 284.2 879.1 8.1
Total $3,491.7 $10,801.2 100.0%
Receipts of the State and Local Government: 2016 Q1
Amount Amount Percent

(billions) per person of receipts
Sales taxes $549.5 $1,699.8 34.7%
Property taxes 466.3 1,442.5 29.5
Personal income taxes 419.0 1,296.1 26.5
Corporate income taxes 58.5 181.0 3.7
Other 88.3 273.1 5.6
Total $1,581.6 $4,892.5 100.0%
Taxes and Efficiency
• Policymakers
– Equity and efficiency
• Costs of taxes to taxpayers
– Tax payment itself
– Deadweight losses
• Taxes distort the decisions that people make
– Administrative burdens
• Taxpayers bear as they comply with the tax
laws
• ‘People respond to incentives’
• Taxes distort incentives
– Cause people to allocate resources
according to tax incentives rather than
true costs and benefits
• Deadweight loss
– The fall in taxpayers’ well-being exceeds
the revenue the government collects
Should income or consumption be taxed?
• Income tax reduces the incentive to
save:
– If income tax rate is 25%, then 8%
interest rate = 6% after-tax interest rate.
– The lost income compounds over time.
• Some economists advocate taxing
consumption instead of income.
– Would restore incentive to save.
– Better for individuals’ retirement income
security and long-run economic growth.
Should income or consumption be taxed?
• Consumption tax-like provisions in the
U.S. tax code include Individual
Retirement Accounts, 401(k) plans.
– People can put a limited amount of
saving into such accounts.
– The funds are not taxed until withdrawn
at retirement.
• Europe’s Value-Added Tax (VAT) is like a
consumption tax
• Administrative burden
– Includes the time and money people
spend to comply with tax laws
– Encourages the expenditure of resources
on legal tax avoidance
• e.g., hiring accountants to exploit “loopholes”
to reduce one’s tax burden
– Is a type of deadweight loss
• Administrative burden
– Could be reduced if the tax code were
simplified
– But would require removing loopholes,
politically difficult
• Average tax rate
– Total taxes paid divided by total income
– Measures the sacrifice a taxpayer makes
• Marginal tax rate
– The extra taxes paid on an additional
dollar of income
– Measures the incentive effects of taxes
on work effort, saving, etc.
• Lump-sum taxes
– Same amount of tax for every person
– Example: lump-sum tax = $4000/person
Income Average tax rate Marginal tax rate
$20,000 20% 0%
$40,000 10% 0%
• Lump-sum taxes
– Most efficient tax possible: a person’s
decisions do not alter the amount owed
• Doesn’t distort incentives, doesn’t cause
deadweight losses
• Imposes a minimal administrative burden
– Perceived as unfair:
• Relative to income, the poor pay much more
than the rich (even though everybody pays
the same in $ terms)
Taxes and Equity
• Equity
– Another goal of tax policy
– Distributing the burden of taxes “fairly.”
• Agreeing on what is “fair” is much harder
than agreeing on what is “efficient.”
– Yet, there are several principles people
apply to evaluate the equity of a tax
system
Taxes and Equity
• The benefits principle
– People should pay taxes based on the
benefits they receive from government
services
– Tries to make public goods similar to
private goods
– Example: Gasoline taxes
• Amount of tax paid is related to how much a
person uses public roads
Taxes and Equity
• The ability-to-pay principle
– Taxes should be levied on a person
according to how well that person can
shoulder the burden
• All taxpayers should make an “equal
sacrifice”
• A $10,000 tax bill is a bigger sacrifice for a
poor person than a rich person.
Taxes and Equity
• Vertical equity
– Taxpayers with a greater ability to pay
taxes should pay larger amounts
• Richer taxpayers should pay more than
poorer taxpayers
• How much more should the rich pay?
The Burden of Federal Taxes
Three Tax Systems
• Proportional tax
– High-income and low-income taxpayers pay the
same fraction of income
• Regressive tax
– High-income taxpayers pay a smaller fraction of
their income than do low-income taxpayers
• Progressive tax
– High-income taxpayers pay a larger fraction of
their income than do low-income taxpayers
Three Tax Systems
Regressive Proportional Progressive

% of % of % of
income tax tax tax
income income income
$50,000 $15,000 30% $12,500 25% $10,000 20%
100,000 25,000 25 25,000 25 25,000 25
200,000 40,000 20 50,000 25 60,000 30
The Federal Income Tax Rates: 2014
Taxes and Equity
• Horizontal equity
– Taxpayers with similar abilities to pay
taxes should pay the same amount
– Special provisions that alter a family’s tax
based on its specific circumstances
– Problem: Difficult to agree on what factors,
besides income, determine ability to pay
Active Learning 1 Taxes and marriage, part 1
The income tax rate is 25%. The first $20,000

of income is excluded from taxation. Tax law
treats a married couple as a single taxpayer.
Sam and Diane each earn $50,000.
i. If Sam and Diane are living together unmarried,
what is their combined tax bill?
ii. If Sam and Diane are married, what is their tax
bill?
Active Learning 1 Answers
If unmarried, Sam and Diane each pay
0.25 x ($50,000 – 20,000) = $7500
Total taxes = $15,000 = 15% of their joint
income.
If married, they pay
0.25 x ($100,000 – 20,000) = $20,000
or 20% of their joint income.
The $5,000 increase in the tax bill is called the
“marriage tax” or “marriage penalty.”
Active Learning 1 Taxes and marriage, part 2
The income tax rate is 25%. For singles, the

first $20,000 of income is excluded from
taxation.
For married couples, the exclusion is $40,000.
Harry earns $0. Sally earns $100,000.

i. If Harry and Sally are living together unmarried,
what is their combined tax bill?
ii. If Harry and Sally are married, what is their tax
bill?
Active Learning 1 Answers
If unmarried, Harry pays $0 in taxes.
Sally pays:
0.25 x ($100,000 – 20,000) = $20,000
Total taxes = $20,000 = 20% of their joint
income.
If married, they pay
0.25 x ($100,000 – 40,000) = $15,000
or 15% of their joint income.
The $5000 decrease in the tax bill is called
the “marriage subsidy.”
Taxes and Equity
• Tax incidence
– Who bears the burden of taxes
– Central to evaluating tax equity
– Person who bears the burden a tax
• Not always the person who gets the tax bill
from the government
• Taxes alter supply and demand
– Alter equilibrium prices
– Indirect effects
Taxes and Equity
• Example: A tax on fur coats
– May appear to be vertically equitable
– But furs are a luxury with very elastic
demand
– The tax shifts demand away from furs,
hurting the people who produce furs
(who probably are not rich)
• When evaluating tax equity, must take tax
incidence into account.
Who pays the corporate income tax?
People pay all taxes
• Tax on a corporation
– Corporation – more like a tax collector
than taxpayer
– Burden of the tax ultimately falls on
people
– Workers and customers bear much of the
burden of the corporate income tax
– Popular because it appears to be paid by
rich corporations
Who pays the corporate income tax?
• Suppose the government levies a tax on
automakers:
– Owners receive less profit, may respond
over time by shifting their wealth out of
the auto industry.
– The supply of cars falls, car prices rise,
car buyers are worse off.
– Demand for auto workers falls, wages
fall, workers are worse off.
Trade-off: Equity vs. Efficiency
• Equity and efficiency
– Most important goals of a tax system
– Often conflict
– Political leaders differ in their views on this
tradeoff
• Economics can help us:
– Better understand the tradeoff
– Avoid policies that sacrifice efficiency
without any increase in equity
Summary
• The U.S. government raises revenue using
various taxes
– Federal government: personal income taxes and
payroll taxes for social insurance.
– State and local governments: sales taxes and
property taxes.
• The efficiency of a tax system refers to the
costs it imposes on taxpayers.
– Deadweight loss: taxes alter incentives
– Administrative burden of complying with the tax
laws.
Summary
• The equity of a tax system concerns whether
the tax burden is distributed fairly among the
population.
– Benefits principle: it is fair for people to pay
taxes based on the benefits they receive
from the government.
– Ability-to-pay principle: it is fair for people to
pay taxes based on their capability to handle
the financial burden.
– The distribution of tax burdens is not the same
as the distribution of tax bills.
Summary
• When considering changes in the tax laws,
policymakers often face a trade-off between
efficiency and equity.
– Much of the debate over tax policy arises
because people give different weights to
these two goals.

Premium CH 12 The Design of The Tax System

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Premium CH 12 The Design of The Tax System

Uploaded by

Copyright:

Available Formats

N.

Amount Amount Percent

Amount Amount Percent

Income Average tax rate Marginal tax rate

Regressive Proportional Progressive

$50,000 $15,000 30% $12,500 25% $10,000 20%

100,000 25,000 25 25,000 25 25,000 25

200,000 40,000 20 50,000 25 60,000 30

The income tax rate is 25%. The first $20,000

The income tax rate is 25%. For singles, the

Harry earns $0. Sally earns $100,000.

You might also like