Transcript Fundamental Principles of Public Finance

Major Tax Structures:
Income Taxes
Troy University
PA6650- Governmental Budgeting
Chapter 8
Three Predominant Tax Bases
• INCOME
• Spending on GOODS & SERVICES
• PROPERTY
Overview
• Governments apply taxes to the income of individuals
and corporations
– Unincorporated business (proprietorship, partnership) is taxed
through the individual income tax system
– Wage and salary income (payrolls) and income of the selfemployed are taxed through the individual income tax and by
separate taxes to finance the social insurance system (Social
Security, unemployment compensation)
– Corporate income taxation is through a separate system
Some Background
• USA relied on excise taxes (customs,
duties, liquor taxes) and tariffs before the
Civil War
• Income Tax levied from 1862-1872
• In 1894 another income tax.
• Struck down by the Supreme Court as a direct tax
• 16th Amendment passed in 1913
• 3-5% income tax in excess of $10,000
• 1% of the population eligible to pay it
Some Background
• In 2004,
–
–
–
–
individual income taxes yielded $1,025.8 billion
Corporate income taxes yielded $258.9 billion
Social Security receipts yielded $822.2 billion
Total receipts of $3.2 trillion (all governments)
• Page 335 of text
– Income tax is 40% of all government receipts
– Income tax is 11% of total GDP
The Argument About Taxing
Income
• FOR
– Income is a reliable indicator of relative
affluence and capacity to bear burden
– Income tax can be made to account for
individual taxpayer conditions (adjustable)
– The size of the income base permits
significant revenue at socially acceptable
rates (good yield)
– The resource distortion is low
The Argument About Taxing
Income
• AGAINST
• Transparency and compliance (complicated,
loopholes)
• Administration and compliance (expensive and
complex to administer)
• Economic effects (some negative effects)
• Economic distortion (some unique groups
punished or favored)
• Equity (distributes the cost of government unfairly)
• Overuse (has become a large burden at several
governmental levels)
Individual Income Taxation
• How it works
– Figure 8-1, page 341
Individual Income Taxation
• Defining Income
•
•
•
•
•
•
•
Wages
Salaries
Interest
Stock dividends
Rents
Royalties
Etc.
Individual Income Taxation
• Haig-Simons says:
– “personal income is defined as the algebraic
sum of 1) the market value of rights exercised
in consumption and 2)the change in the value
of the store of property rights between the
beginning and the end of the period in
question”
(text lists examples of some problems with Haig Simons)
Adjusted Gross Income
• Applies to net income, not gross receipts
• Adjusted for expenses
• Other adjustments (alimony, pensions)
• Many exclusions (food stamps, Social Security,
tax-exempt bonds, life insurance receipts, gifts)
• Tax-exempt municipal bonds are a federal
subsidy to states/localities
Personal Deductions
• May improve horizontal and vertical equity
• Three types of itemized personal
deductions
• Medical, dental, casualty, theft, state & local taxes
(these are not under your control)
• Encouraged spending (charitable contributions,
home mortgage interest)
• Net income adjustments (job expenses, education
expenses, tax prep fees)
• Standard deduction still available (about $5K)
Personal Exemptions
• Flat amount
• About $3k per person
• Table 8-3 page 348
Taxable Income
• Take AGI and subtract personal deductions and
exemptions
• TAX YIELD = TAX BASE x TAX RATE
• Trend is toward broader base, lower rates
Tax Rates
• Federal tax rates increase as income
increases
• AVERAGE RATE = tax liability/taxable
income
• MARGINAL RATE = increase in tax liability
from an additional $1 in income
• Average rate is always below the marginal
rate.
• It means that you will always pay less than a dollar
in tax for an additional dollar earned
Credits
• Direct forgiveness of tax owed…comes
right off of what you owe in tax
• Powerful device to stimulate desired
activity
• Examples include political contributions,
energy saving purchases, home purchase,
child care, low-income EITC)
Effective Tax Rates
• Nominal rates are the published rates
• Marginal rates are each additional dollar
earned
• Average rate is tax liability/taxable income
• AVERAGE EFFECTIVE RATE is taxes
paid/AGI (includes all the credits and
loopholes)
Practice
• Page 358
• Total income = $142,500
• Municipal Bond income = $7,500 (excluded from total
income)
• Adjustments of $12,000
• AGI = $130, 500
• Itemized deductions = $12,500
• 3 EXEMPTIONS @ $3,200 = $9,600
• Taxable income = $130,500 – ($12,500+$9,600) =
$108,400
• Tax table shows a tax owed of $20,480
• WHAT ARE AVERAGE, AVERAGE EFECTIVE,
MARGINAL RATES?
Practice
– AVERAGE RATE
• Tax/Taxable Income
• $20,480 / $108,400 = 18.8%
– AVERAGE EFFECTIVE RATE
• tax / (taxable income+adjustments+exclusions)
• $20,480 / ($108,400 = $12,000 + $7,500) = 16%
– MARGINAL RATE
• change in tax/change in taxable income
• 25% (from the table)
Indexation
• Removes the effect of bracket
creep
– Bracket creep – higher income due to inflation without
any real increase in purchasing power.
Corporate Income Tax
• Corporate net income tax based on net earnings of the
company
• Allows deductions for operating costs and charity
• Federal rate of 35% @$18.3 million or more
• Complex problem calculating depreciation, international
transactions (transfer pricing)
• Different formulas for multiple states based on property,
payroll, or sales
Integration with the
Individual Tax
• Double tax should be eliminated
• Currently there is no full integration
between the individual income tax
and the corporate income tax
Payroll Taxation
• Social Security, Medicare, Unemployment Compensation,
Earned Income Taxes
• Peculiarities of payroll taxes
– Vertical and horizontal equity problems
– Unusual rate patterns
– Earmarks for particular funds
Conclusion
• Income tax is the heart of the federal revenue system
• Problems with income tax include:
– Inefficiency
– Horizontal inequity
– Expensive collection
– Failure of transparency
• Corporate and payroll taxes yield considerable revenue