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Chapter Introduction
Section 1: The Economics of Taxation
Section 2: Federal, State, and Local Revenue Systems
Section 3: Current Tax Issues and Reforms
Visual Summary
Chapter Intro 1
You have just received your first paycheck and are looking forward to being paid $8 per hour for the 20 hours you worked. You look at your check and . . . “What? This check isn’t for $160! Where’s the rest of my money?” Make a list of the deductions that might be subtracted from your earnings. Read Chapter 9 to learn more about how governments raise revenue.
Chapter Intro 2
All levels of government use tax revenue to provide essential goods and services.
Section 1-Preview
Section Preview
In this section, you will learn that taxes are the most important way of raising revenue for the government.
Section 1-Key Terms
Content Vocabulary
• sin tax
• incidence ofa tax
• tax loophole
• individual income tax
• sales tax
• tax return
• benefit principle of taxation
• ability-to-pay principle of taxation
• proportional tax
• average tax rate
• Medicare
• progressive tax
• marginal tax rate
• regressive tax
A. A
B. B
C. C
Section 1
What is the most important way for governments to raise revenue?
A. Sell bonds
B. Sell services
C. Taxes
A B C
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Section 1
Economic Impact of Taxes
Taxes affect the decisions we make in a variety of ways.
Section 1
Economic Impact of Taxes (cont.)
• Taxes and other governmental revenues influence the economy by affecting
– Resource allocation
– Behavior adjustment
• Sin tax
Section 1
Economic Impact of Taxes (cont.)
– Productivity and growth
– Determining incidence of a tax
Shifting the Incidence of a Tax
A. A
B. B
C. C
D. D
Section 1
A B C D
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Which example demonstrates a tax encouraging an activity?
A. Sin tax
B. Interest paid on mortgages
C. Luxury goods tax
D. None of the above
Section 1
Criteria for Effective Taxes
To be effective, taxes must be equitable, easy to understand, and efficient.
Section 1
Criteria for Effective Taxes (cont.)
• Taxes must meet three criteria:
– Equity—impartial and just: Makes sense to avoid tax loopholes
– Simplicity—tax laws written so taxpayers and collectors can understand them
• Individual income tax—complex tax
• Sales tax—simpler
Section 1
Criteria for Effective Taxes (cont.)
– Efficiency—easy to administer and successful in generating revenue
• Individuals file a tax return before April 15th each year.
A. A
B. B
C. C
D. D
Section 1
A B C D
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Which of the taxes below was not worthwhile?
A. Toll booth taxes
B. Sales tax
C. Luxury tax on small private aircraft
D. Gasoline tax
Section 1
Two Principles of Taxation
Taxes can be levied on the basis of benefits received or the ability to pay.
Section 1
• United States taxes are based on two principles
– Benefit principle of taxation
Two Principles of Taxation (cont.)
• Limitations to the benefit principle of taxation
• Those who receive government services are least likely to afford them.
• Benefits are hard to measure and impact others.
Section 1
– Ability-to-pay principle of taxation
• We can’t always measure benefits derived from government spending.
• Assumes individuals taxed more suffer less discomfort paying taxes
Two Principles of Taxation (cont.)
A. A
B. B
Section 1
Which method of taxes better suits you or your family?
A. Benefit principle of taxation
B. Ability-to-pay principle of taxation
A B
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Section 1
Three Types of Taxes
All taxes can be broken down into three categories—proportional, progressive, and regressive.
Section 1
• Three general types of taxes exist in the United States today.
– Proportional tax
Three Types of Taxes (cont.)
• If the percentage tax rate is constant, the average tax rate is constant.
• Medicare tax fund
Three Types of Taxes
Section 1
– Progressive tax
• Marginal tax rate
Three Types of Taxes (cont.)
– Regressive tax
Profiles in Economics:Monica Garcia Pleiman
A. A
B. B
C. C
D. D
Section 1
A B C D
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In which category of taxes does a homeowner’s property tax fall?
A. Proportional tax
B. Progressive tax
C. Regressive tax
D. None of the above
Section 2-Preview
Section Preview
In this section, you will learn that federal, state, and local governments rely on different revenue sources.
Section 2-Key Terms
Content Vocabulary
• Internal Revenue Service (IRS)
• payroll withholding system
• indexing
• FICA
• payroll tax
• corporateincome tax
• excise tax
• estate tax
• gift tax
• customs duty
• user fee
• intergovernmental revenue
• property tax
• tax assessor
• natural monopoly
A. A
B. B
Section 2
The second most important federal revenue source is the individual income tax.
A. True
B. False
A B
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Section 2
Federal, State, and Local Revenue Systems
• The Internal Revenue Service (IRS) is the branch of the U.S. Treasury Department in charge of collecting taxes today.
Section 2
Federal Government Revenue Sources
Individual income taxes, FICA, and borrowing constitute the main sources of government revenue.
Section 2
Federal Government Revenue Sources(cont.)
• Four largest sources of government revenue are
– Individual income taxes
• Tax is mostly collected through a payroll withholding system.
• Tax code takes into account indexing.
Federal Government Revenue Sources
Section 2
Federal Government Revenue Sources(cont.)
– FICA or Federal Insurance Contributions Act tax
• Social Security and Medicare are part of payroll taxes.
– Borrowing by selling bonds to investors
– Corporate income tax
– Excise tax
The Global Economy & YOUTotal Tax Revenue as a Percentage of GDP
Section 2
Federal Government Revenue Sources(cont.)
– Estate tax and gift tax
– Customs duty
– Miscellaneous fees like a user fee
A. A
B. B
C. C
Section 2
Why is indexing so important to the tax code?
A. Lowers the tax on those who pay a gift tax
B. Helps defray costs related to Medicare and Social Security
C. Keeps workers from paying more in taxes because of inflation A B C
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Section 2
State Government Revenue Sources
States rely on funds from the federal government in addition to income taxes and sales taxes.
Section 2
• Largest sources of state governments revenue
– Intergovernmental revenue
– Sales tax implemented by most states
– Individual income taxes by most states
– Other revenue sources
State Government Revenue Sources(cont.)
State and Local Government Revenue Sources
A. A
B. B
C. C
D. D
Section 2
A B C D
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Which of the following states does not charge a general sales tax or individual state income tax?
A. New Hampshire
B. Alaska
C. Washington
D. Delaware
Section 2
Local Government Revenue Sources
Local governments rely mostly on intergovernmental revenue and property taxes.
Section 2
• Largest sources of local governments revenue
– Intergovernmental transfers from state and federal governments
– Property tax
Local Government Revenue Sources(cont.)
• Tax assessor determines valuations of property
State and Local Taxes as a Percentage of State Income
Section 2
– Utility revenues from natural monopolies
– Sales tax
– Other revenue sources
Local Government Revenue Sources(cont.)
A. A
B. B
C. C
D. D
Section 2
A B C D
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Which of the following property does not fall under the property tax laws?
A. Real estate
B. Farm animals
C. Automobile
D. Jewelry
Section 3-Preview
Section Preview
In this section, you will learn that one consequence of tax reform was to make the individual tax code more complex than ever.
Section 3-Key Terms
Content Vocabulary
• payroll withholding statement
• accelerated depreciation
• investment tax credit
• alternative minimum tax
• capital gains
Academic Vocabulary
• concept • controversial
• flat tax
• value-added tax (VAT)
A. A
B. B
C. C
Section 3
Do Americans pay more in taxes than do people in other developed countries?
A. Yes
B. No
C. About the same
A B C
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Section 3
Examining Your Paycheck
The income taxes you pay are summarized on the stub that is attached to your paycheck.
Section 3
Examining Your Paycheck (cont.)
• The payroll withholding statement attached to your paycheck lists deductions taken.
Biweekly Paycheck and Withholding Statement
A. A
B. B
C. C
D. D
Section 3
A B C D
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What is the FICA tax percentage deducted from your paycheck?
A. 6.20%
B. 5.5%
C. 7.65%
D. Varies by individual
Section 3
Tax Reform
Numerous changes have been made to the federal income tax code since 1981.
Section 3
• The Economic Recovery Tax Act, signed by Ronald Reagan in 1981, included large tax reductions for individuals and businesses.
• Businesses also got tax relief from accelerated depreciation and investment tax credit.
Tax Reform (cont.)
Tax Table for Single Individuals, 2006
Section 3
• In 1983 the alternative minimum tax was passed.
• In 1993 government added tax brackets in order to balance the budget.
• The Taxpayer Relief Act of 1997 was both economical and political.
Tax Reform (cont.)
– Capital gains tax was reduced.
Total Government Receipts per Capita, Adjusted for Inflation
Section 3
• Temporary tax reform in 2001—based on the federal government collecting more taxes than it was spending
• Temporary tax reform in 2003—due to slow economic growth, accelerated many of 2001 reforms
• If the present trend of government spending more than it collects in taxes continues, it will be difficult to preserve tax cuts due to expire in 2011.
Tax Reform (cont.)
A. A
B. B
C. C
D. D
Section 3
A B C D
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What do you think Congress should do now regarding taxes?
A. Keep everything the same
B. Reduce government spending
C. Increase taxes
D. Change the tax structure all together
Section 3
Alternative Tax Approaches
The need for new federal revenues will influence future tax reform.
Section 3
• Two alternative forms of taxation
– Flat tax
– Value-added tax (VAT)
Alternative Tax Approaches (cont.)
The Value-Added Tax
Section 3
• Advantages to the flat tax
– Simplicity to taxpayer
– Closes most loopholes
– Reduces need for many workers in IRS and tax preparers
Alternative Tax Approaches (cont.)
Section 3
• Disadvantages to the flat tax
– Removes many incentives built into current tax code
– Don’t know what rate is needed to replace revenues collected today
– Unsure if flat tax would stimulate economic growth
Alternative Tax Approaches (cont.)
Section 3
• Advantages to the VAT
– Tax is hard to avoid
– Tax incidence is widespread
– Easy to collect
– Encourages saving
Alternative Tax Approaches (cont.)
Section 3
• Disadvantage to the VAT
– Virtually invisible—other factors can change the product’s price.
Alternative Tax Approaches (cont.)
• Desires to simplify the tax code, unexpected expenditures on war and natural disasters, and political change all result in tax reform.
A. A
B. B
C. C
D. D
Section 3
A B C D
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Why is it difficult for politicians to change the tax code completely?
A. Hard to give up power of modifying behavior and influencing allocation of resources
B. They support their own pet projects.
C. They find it hard to grant concessions to special interest groups.
D. All of the above
Types of Taxes All taxes in the United States can be broken down into three categories: proportional, progressive, and regressive
VS 1
VS 2
Government Revenue Sources Federal, state, and local revenue sources differ. Much of the federal revenue is sent on to state and local governments.
VS 3
Alternative Tax Approaches Because the federal tax code has become so large and cumbersome, people have discussed the flat tax and the value-added tax as two alternatives.
Figure 1
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Figure 3
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Figure 6
Figure 7
Figure 8
Figure 9
Figure 10
Profile
Monica Garcia Pleiman (1964– )
• president and CEO of OMS, a technology consulting firm
• publisher of Hispanic lifestyles magazine Latino SUAVE
• cofounder of the Latina Chamber of Commerce
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Vocab1
sin tax
relatively high tax designed to raise revenue and discourage consumption of a socially undesirable product
Vocab2
incidence of a tax
final burden of a tax
Vocab3
tax loophole
exception or oversight in the tax law allowing taxpayer to avoid paying certain taxes
Vocab4
individual income tax
federal tax levied on the wages, salaries, and other income of individuals
Vocab5
sales tax
general state or city tax levied on a product at the time of sale
Vocab6
tax return
annual report by a taxpayer filed with local, state, or federal government detailing income earned and taxes owed
Vocab7
benefit principle of taxation
belief that taxes should be paid according to benefits received regardless of income
Vocab8
ability-to-pay principle of taxation
belief that taxes should be paid according to level of income, regardless of benefits received
Vocab9
proportional tax
tax in which percentage of income paid in tax is the same regardless of the level of income
Vocab10
average tax rate
total taxes paid divided by the total taxable income
Vocab11
Medicare
federal health-care program for senior citizens
Vocab12
progressive tax
tax in which the percentage of income paid in tax rises as the level of income rises
Vocab13
marginal tax rate
tax rate that applies to the next dollar of taxable income
Vocab14
regressive tax
tax in which the percentage of income paid in tax goes down as income rises
Vocab15
validity
justification
Vocab16
evolved
developed gradually
Vocab17
Internal Revenue Service (IRS)
branch of the U.S. Treasury Department that collects taxes
Vocab18
payroll withholding system
system that automatically deducts income taxes from paychecks on a regular basis
Vocab19
indexing
adjustment of tax brackets to offset the effects of inflation
Vocab20
FICA
Federal Insurance Contributions Act; tax levied on employers and employees to support Social Security and Medicare
Vocab21
payroll tax
tax on wages and salaries deducted from paychecks to finance Social Security and Medicare
Vocab22
corporate income tax
tax on corporate profits
Vocab23
excise tax
general revenue tax levied on the manufacture or sale of selected items
Vocab24
estate tax
tax on the transfer of property when a person dies
Vocab25
gift tax
tax paid by the donor on transfer of money or wealth
Vocab26
customs duty
tax on imported products
Vocab27
user fee
fee paid for the use of good or service
Vocab28
intergovernmental revenue
funds that one level of government receives from another level of government
Vocab29
property tax
tax on tangible and intangible possessions such as real estate, buildings, furniture, stocks, bonds, and bank accounts
Vocab30
tax assessor
person who examines and assesses property values for tax purposes
Vocab31
natural monopoly
market structure in which average costs of production are lowest when a single firm exists
Vocab32
implemented
put into effect
Vocab33
considerably
to a noticeable or significant extent
Vocab34
payroll withholding statement
document attached to a paycheck summarizing pay and deductions
Vocab35
accelerated depreciation
schedule that spreads depreciation over fewer years to generate larger tax reductions
Vocab36
investment tax credit
tax credit given for purchase of equipment
Vocab37
alternative minimum tax
personal income tax rate that applies to cases in which taxes would otherwise fall below a certain level
Vocab38
capital gains
profits from the sale of an asset held for 12 months or longer
Vocab39
flat tax
proportional tax on individual income after a specified threshold has been reached
Vocab40
value-added tax (VAT)
tax on the value added at every stage of the production process
Vocab41
concept
general idea
Vocab42
controversial
disputed
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