The Design of the tax system

“In this world nothing is certain but death and taxes.”
. . . Benjamin Franklin
Taxes paid in Ben Franklin’s time accounted for 5 percent of the average American’s income.
1789

“In this world nothing is certain but death and taxes.”
. . . Benjamin Franklin
1789
Today, taxes account for up to a third of the average American’s income.

Figure 1 Government Revenue as a Percentage of GDP
Copyright © 2004 South-Western
0
5
10
15
20
25
30
35
Revenue as
Percent of
GDP
1902
1922
1927
1913
1940
1932
1970
1980
1990
2000
1950
1960

Table 1 Central Government Tax Revenue as a Percent of GDP
Copyright©2004 South-Western

2012

The Federal Government
The U.S. federal government collects about two-thirds of the taxes in our economy.

The Federal Government
The largest source of revenue for the federal government is the individual income tax.

The Federal Government
Individual Income Taxes
The marginal tax rate is the tax rate applied to each additional dollar of income.
Higher-income families pay a larger percentage of their income in taxes.

The Federal Government
The Federal Government and Taxes
Payroll Taxes: tax on the wages that a firm pays its workers.
Social Insurance Taxes: taxes on wages that is earmarked to pay for Social Security and Medicare.
Excise Taxes: taxes on specific goods like gasoline, cigarettes, and alcoholic beverages.

Table 2 Receipts of the Federal Government: 2001
Copyright©2004 South-Western

Receipts of the Federal Government...

The Federal Government
Federal Government Spending
Government spending includes transfer payments and the purchase of public goods and services.
Transfer payments are government payments not made in exchange for a good or a service.
Transfer payments are the largest of the government’s expenditures.

The Federal Government
Federal Government Spending
Expense Category:
Social Security
National Defense
Income Security
Net Interest
Medicare
Health
Other

The Federal Government
Budget Surplus
A budget surplus is an excess of government receipts over government spending.
Budget Deficit
A budget deficit is an excess of government spending over government receipts.

Table 4 Spending of the Federal Government: 2001
Copyright©2004 South-Western

Federal Government Spending: 2001

The Federal Government
Financial Conditions of the Federal Budget
A budget deficit occurs when there is an excess of government spending over government receipts.
Government finances the deficit by borrowing from the public.
A budget surplus occurs when government receipts are greater than government spending.
A budget surplus may be used to reduce the government’s outstanding debts.

State and Local Governments
State and local governments collect about 40 percent of taxes paid.

State and Local Government
Receipts
Sales Taxes
Property Taxes
Individual Income Taxes
Corporate Income Taxes
Federal government
Other
Taxes
$

Table 5 Receipts of State and Local Governments: 1999
Copyright©2004 South-Western

State and Local Government
Spending
Education
Public Welfare
Highways
Other

Table 6 Spending of State and Local Governments: 1999
Copyright©2004 South-Western

TAXES AND EFFICIENCY
Policymakers have two objectives in designing a tax system...
Efficiency
Equity

TAXES AND EFFICIENCY
One tax system is more efficient than another if it raises the same amount of revenue at a smaller cost to taxpayers.
An efficient tax system is one that imposes small deadweight losses and small administrative burdens.

TAXES AND EFFICIENCY
The Cost of Taxes to Taxpayers
The tax payment itself
Deadweight losses
Administrative burdens

Deadweight Losses
Because taxes distort incentives, they entail deadweight losses.
The deadweight loss of a tax is the reduction of the economic well-being of taxpayers in excess of the amount of revenue raised by the government.

Administrative Burdens
Complying with tax laws creates additional deadweight losses.
Taxpayers lose additional time and money documenting, computing, and avoiding taxes over and above the actual taxes they pay.
The administrative burden of any tax system is part of the inefficiency it creates.

Marginal Tax Rates versus Average Tax Rates
The average tax rate is total taxes paid divided by total income.
The marginal tax rate is the extra taxes paid on an additional dollar of income.

Lump-Sum Taxes
A lump-sum tax is a tax that is the same amount for every person, regardless of earnings or any actions that the person might take.
(аккордный налог)

TAXES AND EQUITY
How should the burden of taxes be divided among the population?
How do we evaluate whether a tax system is fair?

TAXES AND EQUITY
Principles of Taxation
Benefits principle
Ability-to-pay principle
$

Benefits Principle
The benefits principle is the idea that people should pay taxes based on the benefits they receive from government services.
An example is a gasoline tax:
Tax revenues from a gasoline tax are used to finance our highway system.
People who drive the most also pay the most toward maintaining roads.

Ability-to-Pay Principle
The ability-to-pay principle is the idea that taxes should be levied on a person according to how well that person can shoulder the burden.
The ability-to-pay principle leads to two corollary notions of equity.
Vertical equity
Horizontal equity

Ability-to-Pay Principle
Vertical equity is the idea that taxpayers with a greater ability to pay taxes should pay larger amounts.
For example, people with higher incomes should pay more than people with lower incomes.

Ability-to-Pay Principle
Vertical Equity and Alternative Tax Systems
A proportional tax is one for which high-income and low-income taxpayers pay the same fraction of income.
A regressive tax is one for which high-income taxpayers pay a smaller fraction of their income than do low-income taxpayers.
A progressive tax is one for which high-income taxpayers pay a larger fraction of their income than do low-income taxpayers.

Ability-to-Pay Principle
Horizontal Equity
Horizontal equity is the idea that taxpayers with similar abilities to pay taxes should pay the same amounts.
For example, two families with the same number of dependents and the same income living in different parts of the country should pay the same federal taxes.

Table 7 Three Tax Systems
Copyright©2004 South-Western

Table 8 The Burden of Federal Taxes
Copyright©2004 South-Western

Федеральные налоги и сборы:
Налог на добавленную стоимость 18
Акцизы
Налог на доходы физических лиц 13
Соц. страховые взносы 22+2.9+5.1
Налог на прибыль организаций 20
Налог на добычу полезных ископаемых
Водный налог
Сборы за пользование объектами животного мира и за пользование объектами водных биологических ресурсов
Государственная пошлина

Региональные налоги:
Налог на имущество организаций
Налог на игорный бизнес
Транспортный налог
Местные налоги:
Земельный налог
Налог на имущество физических лиц
Специальные налоговые режимы:
Единый сельскохозяйственный налог — ЕСХН
Упрощенная система налогообложения
Единый налог на вменённый доход
Система налогообложения при выполнении соглашений о разделе продукции

CASE STUDY: Horizontal Equity and the Marriage Tax
Marriage affects the tax liability of a couple in that tax law treats a married couple as a single taxpayer.
When a couple gets married, they stop paying taxes as individuals and start paying taxes as a family.
If each has a similar income, their total tax liability rises when they get married.

Tax Incidence and Tax Equity
The difficulty in formulating tax policy is balancing the often conflicting goals of efficiency and equity.
The study of who bears the burden of taxes is central to evaluating tax equity.
This study is called tax incidence.

Tax Incidence and Tax Equity
Flypaper Theory of Tax Incidence
According to the flypaper theory, the burden of a tax, like a fly on flypaper, sticks wherever it first lands.
(this is wrong, of course)

Summary
The U.S. government raises revenue using various taxes.
Income taxes and payroll taxes raise the most revenue for the federal government.
Sales taxes and property taxes raise the most revenue for the state and local governments.

Summary
Equity and efficiency are the two most important goals of the tax system.
The efficiency of a tax system refers to the costs it imposes on the taxpayers.
The equity of a tax system concerns whether the tax burden is distributed fairly among the population.

Summary
According to the benefits principle, it is fair for people to pay taxes based on the benefits they receive from the government.
According to the ability-to-pay principle, it is fair for people to pay taxes on their capability to handle the financial burden.