21
Categories of taxation Taxes on income Income tax FICA (social security) tax Disability tax Taxes on spending Sales tax Excise tax Taxes on wealth Property tax Estate and inheritance taxes

Categories of taxation Taxes on income – Income tax – FICA (social security) tax – Disability tax Taxes on spending – Sales tax – Excise tax Taxes on wealth

Embed Size (px)

Citation preview

Page 1: Categories of taxation Taxes on income – Income tax – FICA (social security) tax – Disability tax Taxes on spending – Sales tax – Excise tax Taxes on wealth

Categories of taxation

Taxes on income

– Income tax

– FICA (social security) tax

– Disability tax Taxes on spending

– Sales tax

– Excise tax Taxes on wealth

– Property tax

– Estate and inheritance taxes

Page 2: Categories of taxation Taxes on income – Income tax – FICA (social security) tax – Disability tax Taxes on spending – Sales tax – Excise tax Taxes on wealth

Taxes create incentives that distort economic activity

People do less of the activities that are taxed People do more of the activities that are tax-

exempt or subsidized Examples

– mortgage interest deduction encourages home ownership and borrowing, punishes renters

– child credit encourages breeding

– marriage penalty encourages fathers to abandon their families

Page 3: Categories of taxation Taxes on income – Income tax – FICA (social security) tax – Disability tax Taxes on spending – Sales tax – Excise tax Taxes on wealth

Tax compliance is a huge additional burden

Tax code is about 4 million words Estimated national compliance cost: $168 billion

plus 6 billion hours of effort 59% of individuals pay tax preparers, 30% use

tax software Public choice theory explains tax complexity

– Politicians have incentive to insert tax provisions that benefit their particular constituency

– No one is looking after the overall cost and complexity of the tax code as a whole

Page 4: Categories of taxation Taxes on income – Income tax – FICA (social security) tax – Disability tax Taxes on spending – Sales tax – Excise tax Taxes on wealth

Do corporations pay taxes?

Corporations are subject to income taxes Corporations are not people. Tax burdens

imposed on corporations are borne by Stockholders: lower dividends & capital gains Employees: lower salaries Customers: higher prices

Page 5: Categories of taxation Taxes on income – Income tax – FICA (social security) tax – Disability tax Taxes on spending – Sales tax – Excise tax Taxes on wealth

How taxes distort corporate finance

Dividends are taxed twice

– paid out of corporate earnings after tax

– taxable to shareholder recipients

– partly offset by Bush tax reforms Interest paid by corporations

– deductible from corporate taxable income

– taxable to bondholder recipients Tax incentivizes debt finance over equity

Page 6: Categories of taxation Taxes on income – Income tax – FICA (social security) tax – Disability tax Taxes on spending – Sales tax – Excise tax Taxes on wealth

Taxes incentivize evasion and avoidance

Evasion is illegal; avoidance is legal Examples of evasion

– Income tax: unreported cash payments

– Sales tax: cash payments, under-reporting

– Property taxes: under-state tax basis

– Death taxes: gifts of cash or gold

Page 7: Categories of taxation Taxes on income – Income tax – FICA (social security) tax – Disability tax Taxes on spending – Sales tax – Excise tax Taxes on wealth

Progressive income tax

Most income tax systems are progressive: higher percentage levied on higher incomes

Federal income tax rates, married filing jointly 10% of first $18,150 15% to $73,800 25% to $148,850 28% to $226,850 33% to $405,100 35% to $457,000 39.6% above $457,000

Page 8: Categories of taxation Taxes on income – Income tax – FICA (social security) tax – Disability tax Taxes on spending – Sales tax – Excise tax Taxes on wealth

Tax on $100,000 taxable income

10% of $18,500 $1,850

15% of (73,800-18,500) $8,295

25% of (100,000-73,800) $6,550

Total $16,695

Average rate 16,695/100,000 = 16.69%

Marginal rate 25%

– This rate is relevant to incentives to work and save

Page 9: Categories of taxation Taxes on income – Income tax – FICA (social security) tax – Disability tax Taxes on spending – Sales tax – Excise tax Taxes on wealth

Tax on $500,000 taxable income

10% of $18,500 $1,850

15% of (73,800-18,500) $8,295

25% of (226,850-73,800) $38,262

28% of (405,100-226,850) $49,910

33% of (457,000-405,100) $17,120

39.6% of (500,000-457,000) $17,028

Total $132,465

Average rate = 132,465/500,000 = 26.49%

Marginal rate = 39.6%

5x increase in income → 8x increase in tax

Page 10: Categories of taxation Taxes on income – Income tax – FICA (social security) tax – Disability tax Taxes on spending – Sales tax – Excise tax Taxes on wealth

Progressive taxation, pro and con

“Ability to pay” principle:

– Wealthy person suffers less from extraction of an additional $1 in taxes than does a poor person

– Therefore progressive income taxes impose roughly the same burden on all

Counter-argument

– Interpersonal utility comparison is not possible

– Many high-income people direct large amounts of their income to saving and investing or to charity (T. J. Rodgers)

Page 11: Categories of taxation Taxes on income – Income tax – FICA (social security) tax – Disability tax Taxes on spending – Sales tax – Excise tax Taxes on wealth

Tax deductions

Subtract deductions from gross income to get taxable income

Common deductions Mortgage interest Medical expense, but only the portion in

excess of 7.5% of gross income Donations to charity Real estate taxes State income tax (deductible from federal)

Page 12: Categories of taxation Taxes on income – Income tax – FICA (social security) tax – Disability tax Taxes on spending – Sales tax – Excise tax Taxes on wealth

Tax credits

Subtracted from tax payable

– Much more valuable than tax deductions, which reduce your tax due by your marginal tax rate times amount of deduction

Examples

– Foreign tax paid

– Earned income credit

– Education credit (?)

Page 13: Categories of taxation Taxes on income – Income tax – FICA (social security) tax – Disability tax Taxes on spending – Sales tax – Excise tax Taxes on wealth

Taxes paid by investors

Interest and non-qualified dividends Taxed like wage income

Qualified dividends Taxed at 0%, 15% or 20% Offsets double taxation since corporations

pay dividends out of their after-tax income Capital gains

Held less than one year: ordinary income More than one year: 15% or 20%

Page 14: Categories of taxation Taxes on income – Income tax – FICA (social security) tax – Disability tax Taxes on spending – Sales tax – Excise tax Taxes on wealth

Tax deferral

Wage earners are given incentive to save for retirement using tax-deferred accounts

Example: $10,000 saved for 30 years at 5% interest, 25% marginal tax bracket

Tax deferred: 10000x1.0530 = $43,219, then subtract 25%

income tax, leaving $32,415 Not deferred:

7500 after tax income compounded at after-tax rate of 5% x (1-0.25) = 3.75%

7500x1.037530 = $22,631

Page 15: Categories of taxation Taxes on income – Income tax – FICA (social security) tax – Disability tax Taxes on spending – Sales tax – Excise tax Taxes on wealth

Pensions

Offered by governments and a decreasing number of private companies

Contributions From employee’s pre-tax income From employer

Employee gets an annuity at retirement Many pension funds have made unrealistic

assumptions

Page 16: Categories of taxation Taxes on income – Income tax – FICA (social security) tax – Disability tax Taxes on spending – Sales tax – Excise tax Taxes on wealth

Social security

Almost all wages are subject to FICA (social security) tax

– 6.2% nominally paid by employer

– 6.2% nominally paid by employee

– tax is regressive, no tax on income above $100,000

– self-employed people must pay 12.4% Medicare tax is an additional 2.3% on all

income

Page 17: Categories of taxation Taxes on income – Income tax – FICA (social security) tax – Disability tax Taxes on spending – Sales tax – Excise tax Taxes on wealth

Social security

Normal retirement age is 66 (rising to 67) Payments are based on employment history

– Fosters the illusion that your payments are set aside for you to draw on during retirement

– Congress can change payments any time

– Formerly tax free, then 50% subject to income tax, now 85%

Automatic yearly inflation adjustment

Page 18: Categories of taxation Taxes on income – Income tax – FICA (social security) tax – Disability tax Taxes on spending – Sales tax – Excise tax Taxes on wealth

Social security

Massive increase in social security tax rates in 1983 led to annual surpluses, which were invested in Treasury securities

Taxes no longer cover payouts – some interest income being used. After that, some rollovers will stop. After that, some bonds will have to be sold prior to maturity.

Social security trust fund is an accounting fiction

– Trust fund money has been spent by the Treasury

Page 19: Categories of taxation Taxes on income – Income tax – FICA (social security) tax – Disability tax Taxes on spending – Sales tax – Excise tax Taxes on wealth

401k and IRA

401k offered by most large companies Pre-tax earnings contributed to account Matched by employers in many cases Penalty for withdrawal prior to age 59.5

except in special circumstances Withdrawals must begin by age 70.5

IRA available to workers without an employer program, similar to 401k

Page 20: Categories of taxation Taxes on income – Income tax – FICA (social security) tax – Disability tax Taxes on spending – Sales tax – Excise tax Taxes on wealth

Investments allowed in IRA

Shares of stock Bonds Mutual funds, ETFs Sale of covered calls Real estate, gold bullion (?) Not allowed: short sales, option trading other

than sales of covered calls, futures contracts

Page 21: Categories of taxation Taxes on income – Income tax – FICA (social security) tax – Disability tax Taxes on spending – Sales tax – Excise tax Taxes on wealth

IRA and 401k pro and con

Pro

– Tax deferral is a significant benefit

– Automatic saving

– Employer matching of 401k contributions is like free money

Con

– Vulnerable to confiscation or taxation by politicians