GOVERNMENT REVENUE

&SPENDING

Chapter 14

History of Taxation in the US

What is a tax? revenue?Articles of Confederation 1781-1789

U.S. had no power to compel payment from the states to operate the federal government.

The states were not paying their bills

Federal Constitution 1789-1790 Federal government given clearly defined

taxing powers Two forms of taxation only:

direct and indirect

The Two Classes of Tax Direct Taxes

Taxes upon people, real property, certain rights. E.g. income tax, property tax, estate tax, gift tax, driver’s

license

Indirect Taxes (excise taxes) Taxes on certain activities which can be avoided by

refraining from those activities Eg. Import duties, sales tax, gasoline tax

The Civil War

First income tax; later held to be unconstitutionalThe 16th AmendmentThe Origin of today’s Income Tax

Originated as an idea to “soak the rich.” Ratified by the states in Feb. 1913 The first tax bill passed in Congress in Oct. 1913 The tax rates ranged from 1% to 7% Only 5% of the population was required to file tax

returns (today – 80%) Withholding from wages and salaries started by

FDR in 1943

The constitutionality of the income tax continues to be questionedBUT …regardless of what anyone believes on the constitutionality of the income tax, the IRS has the power to compel payment

Social Security Tax

Social Security Act – 1935 A reaction to the Great

Depression Intended to provide

unemployment compensation to workers who lost their jobs

Originally a 2% tax – half from employee, half from employer

Now a 12.4% tax – 6.2% payroll deduction from employee & employer pays in 6.2%

#1 - Progressive People taxed at

increasing rate as income rises. E.g., 10% on first

$20,000, 20% on next $20,000, 25% 0n next$ 60,000, 30% on anything over $100,000.

Proportion of tax paid increases as income increases.

Income Taxes

The Three General Types of TaxesClassified according to way the tax burden changes as income changes

#2 - Regressive Tax levied without regard to a

taxpayer’s income or ability to pay

Puts higher percentage rate of taxation on lower incomes

Percent paid decreases as income increases E.g., Social Security taxes (12.4%

of gross pay)– which end after a maximum amount deducted (after about $97,500).

For example: a salary of $50,000 – 12.4% payroll tax paid

A salary of $150,000 – 12.4% paid on first $97,500, $0 on remaining $52,500

The Three General Types of Taxes

Sales Taxes have a regressive effect:

Not a tax based on income, but based on a percentage of what you purchase

But affects people’s incomes in a regressive manner:

For example: A person with $20, 000/ yr income buys $5,000 of

necessities. 5% sales tax = $250 = %1.25 of income

Person with $100,000/ yr income buys $5,000 of necessities. 5% sales tax = $250 = %.25 of income So in reality, they put a higher rate of taxation on low

incomes than high ones --- they take a higher rate of the income from low income earners

The Three General Types of Taxes#3 - Proportional Taxes -

Everyone taxed at same rate Tax which takes an equal proportion

of income whatever the taxpayer's income.

Takes the same percentage of income from everyone regardless of how much (or little) an individual earns.

For example, assume that income is taxed with a 20% “flat tax ” a person earning $20,000 per year

would pay $4,000 in taxes A person earning $100,000 per year

would pay $20,000 The percentage doesn’t change with

income changes

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

Contrasts with regressive tax where the proportion paid falls as income increases, and progressive tax where the proportion paid increases as income increases.

Government Sources of Revenue

Federal Individual income tax Corporate taxes Payroll tax - FICA

Social Security & MedicareState

Income tax Sales tax

Local Property tax Sales tax

Four Criteria For Taxes to be Effective –a “good tax”

#1 - Simplicity Most people think tax laws should be simple and

understandable. Are they? 6000 + printed pages. Call IRS and get a different answer every time

#2 -Equity Taxes should be impartial and fair. No one should have too

much or too little of the tax burden. Definition of “fair” varies: tax everyone equally, flat tax, tax

the rich more, tax someone else…. Loopholes unfair.

#3 – Certainty Needs to be clear as to how much is owed, when it’s due and

how it is to be paid ------ is this clear in the U.S.?

Four Criteria For Taxes to be Effective

#4 - Efficiency

• Should be easy to administer; generate revenue successfully.

• The U.S. income tax system is good at this since it is deducted from your paycheck!

• Others not so good – for example,• toll booths – a lot of effort for

really very little return

Basic Economic Impact of Taxes

Resource allocation Tax placed on good or service increases

cost of production, decreases supply, & increases price.

People react by buying less, manufacturers cut production, lay off workers, capital allocated elsewhere or unused

People’s behavior Some taxes are specifically designed to

change people’s behavior i.e., sin taxes on tobacco and liquor.

Can generate a great deal of revenue

taxes

Basic Economic Impact of Taxes

Productivity and growth Some taxes may hinder productivity and growth if

people think they are too high. Loss of incentive to work. Businesses may not expand production. Less savings available for borrowing and

investment.

Two Principles of Taxation

# 1 – Benefit Principle Those who benefit should pay e.g., airport tax, toll roads

People should pay in proportion to amount of benefit/services received Gasoline taxes are used to pay

for streets and highways. Those who drive more use the

roads more and pay more.

Two Principles of Taxation

#2 - Ability to PayPeople should pay according to their ability to

pay regardless of services received. Assumes benefits cannot always be

measured, and some people will suffer less by paying than others.

Progressive income tax is an example of this principle.

FEDERAL TAXES

PERSONAL INCOME TAXESCorporate Income TaxesPayroll Taxes – paid by who?

Social Security Medicare

Unemployment Taxes – paid by who?Excise Taxes – paid by who? main purpose?Estate Taxes – what’s included? Who pays?Gift Taxes – applies to gifts over $__?Import Taxes / Tariffs / Customs duties

When are personal income taxes due?

Tax Returns must be postmarked by midnight,April 15th!

Tax Return = form used to declare your income (for the previous calendar year) and determine how much of it is taxable.

INDIVIDUAL INCOME TAX BRACKETS, 2014

Table 1. 2014 Taxable Income Brackets and Rates

Rate Single Filers Married Joint FilersHead of Household

Filers

10% $0 to $9,075 $0 to $18,150 $0 to $12,950

15% $9,076 to $36,900 $18,151 to$73,800 $12,951 to $49,400

25% $36,901 to $89,350 $73,801 to $148,850 $49,401 to $127,550

28% $89,351 to $186,350 $148,851 to $226,850 $127,551 to $206,600

33% $186,351 to $405,100 $226,851 to $405,100 $206,601 to $405,100

35% $405,101 to 406,750 $405,101 to 457,600 $405,101 to $432,200

39.6% $406,751+ $457,601+ $432,201+

Congress establishes these annual tax rates.

Source: Internal Revenue Service

GOVERNMENT SPENDING

Federal Government SpendingThe Federal Budget

•An annual process1. OMB prepares budget with P2. Sends to Congress / passes Budget bill3. Sends to P for signature

•Fiscal year is Oct. 1 – Sept. 30

Two kinds of spending in the budget:Mandatory – amounts that must be spent – they are mandated

or required by law – e.g., Social Security, interestpayments on the debt, Medicare

Discretionary – lawmakers are free to make choices on how much to spend -

e.g., defense, education, highways, etc.

ENTITLEMENT PROGRAMS - MANDATORY:• Social welfare programs that people are entitled to if they meet certain eligibility requirements such as age or being at a particular income level.• Make up bulk of government spending!

•Social Security (50 million Americans)• Retired, disabled

•Medicare (42 million Americans)• Hospital care, physicians & medical services

•Medicaid• Low-income families, elderly in nursing homes• Shared cost with state governments

•Unemployment compensation•Veterans’ pensions•Food stamps; WIC

Why are entitlement programcosts going up?

Federal government is limited in how much it canchange spending levels due to entitlement programs.

STATE REVENUE & SPENDING

Where do states get most of their revenue? Income taxes – flat tax or progressive tax

States with NO income tax are: AK, FL, NV, NH, SD, TN, TX, WA, WY

Sales taxes

Where do states spend the most?

Education Public Safety Highways/recreation Public welfare