Sources of Government Revenue

Economic Impact of Taxes

• Resource Allocation• Factors of

production are affected

• Raise in production costs

• Higher prices = less demand = increase unemployment

Economic Impact of Taxes

• Behavior Adjustment• Encourage or

discourage certain activities

• “sin tax”: high % tax that raises revenue while reducing consumption of a socially undesirable product

Economic Impact of Taxes

• Productivity– Change incentives to save,

invest, and work• The Incidence of a Tax– The party being taxed is

not always the one that bears the burden of a tax.

– Higher taxes on utility company = higher utility bills

Criteria for Effective Taxes

• Criterion One: Equity– Fairness is subjective– Tax loopholes: Can they be avoided?– Taxes are generally viewed as fair if there are

fewer exemptions, exceptions, and deductions

Criteria for Effective Taxes

• Criterion Two: Simplicity• Tax laws should be easy to understand

Criteria for Effective Taxes

• Criterion Three: Efficiency• Easy to administer and can generate revenue

easily

Two Principles of Taxation• Benefit Principle

• Those who benefit from the government should pay in proportion to the amount of benefits they receive

• Gasoline: If you drive more, then you pay more gas tax = more $$ for highway upkeep

• Two limitations:– Most government benefits go to those least able

to pay for them– Benefits are hard to measure

Two Principles of Taxation

• Ability-to-Pay Principle• People should be taxed according to their

ability to pay, regardless of benefits received• Ex: individual income tax• Two factors:• Benefits derived from government spending

cannot always be measured• Assumes higher income earners suffer less

discomfort in paying taxes than lower income earners

Types of

• Proportional• Imposes the same tax rate %

on everyone, regardless of income

• As income increases, the % of income tax stays the same.

• If tax rate is 20%, a person making $10,000 pays? A person making $100,000 pays?

Types of Taxes• Progressive Tax

• Imposes a higher tax rate % on persons with higher incomes

• Ex? Income Tax• As income increases,

the % of income paid in taxes also goes up

Types of

• Regressive Tax Example?• State sales tax• As income goes up, the % of income paid in

taxes goes down– Someone making $10,000/yr may spend $5,000

on food and clothing– Someone making $100,000 may spend $20,000 on

same essentials• If state sales tax is 4%, the lower income

household is paying a higher % of total taxes

Section 2: The Federal Tax System• Individual Income Taxes• Gov collects about 48% of revenue from

individual income tax• W/held from individual’s paychecks, with

employers sending taxes directly to IRS• Individuals file a tax return on/before April 15

each year.– If taxes w/held > taxes owed = refund– If taxes w/held < taxes owed = individual pays

balance

FICA

• Federal Insurance Contributions Act– Largest source of

government revenue– Regressive

• Medicare• Social Security Taxes:

Partially proportional, partially regressive

Quiz

1. What are the 3 the criteria for effective taxes?2. What are the 2 principles of taxation?3. What are the 3 types of taxes?4. What two areas or taxes make up FICA?5. What percentage of revenue is collected by the

Federal Government in the form of income tax?6. What is a progressive tax?7. What is a regressive tax?8. What does FICA stand for?