Taxation: Evaluating Revenue Sources Lecture 5 September 27,
2005 PA 546 Constantine Hadjilambrinos
Slide 2
Taxation The only method to share burden of provision of public
goods. The only method to share burden of provision of public
goods. May also be used to share cost of common- pool and toll
goods. May also be used to share cost of common- pool and toll
goods. Only socially acceptable way to re-distribute wealth. Only
socially acceptable way to re-distribute wealth. PA 546 Constantine
Hadjilambrinos
Slide 3
Criteria for designing a good tax system Equity Economic
efficiency Economic efficiency Collection costs (to collector &
to society) Collection costs (to collector & to society)
Revenue consequences Revenue consequences PA 546 Constantine
Hadjilambrinos The levying of taxes requires coercive authority For
this reason, government must be careful when it comes to designing
and implementing tax systems.
Slide 4
Equity Distribution according to benefits Distribution
according to ability to pay Distribution according to benefits is
impractical for public goods. How is ability to pay
defined/measured? Property Property Income Income Net wealth Net
wealth PA 546 Constantine Hadjilambrinos
Slide 5
Horizontal equity: Everyone with the same ability to pay pays
equal amount. Vertical equity: Concerns proper relationship between
tax burdens of individuals with different capabilities to pay.
Redistribution issue Regressive: People with greater ability to
pay, pay proportionately less. Proportional: People pay same
proportion (of income, wealth, etc.) Progressive: People with
greater ability to pay, pay proportionately more. PA 546
Constantine Hadjilambrinos
Slide 6
Is there an economic justification for a progressive tax
structure? Diminishing marginal utility argument: Low- income
individuals value additional unit of income than high-income
individuals. Diminishing marginal utility argument: Low- income
individuals value additional unit of income more than high-income
individuals. Progressive tax structure increases overall societal
welfare. PA 546 Constantine Hadjilambrinos
Slide 7
Who really pays? (Tax incidence) Taxpayer may be able to shift
some or all of the cost of a tax to someone else. Forward shift:
Shift to consumersincrease prices. Forward shift: Shift to
consumersincrease prices. Backward shift: Shift to suppliersreduce
prices paid to them. Backward shift: Shift to suppliersreduce
prices paid to them. Absorption: Absorb taxlower return to owners.
Absorption: Absorb taxlower return to owners. Businesses respond so
as to maximize after-tax returns to owners. PA 546 Constantine
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Slide 8
Table 7-5 Federal Tax Distribution and Effective Rates by
Quintiles for All Families, 1980-1996 1980198519901995 Quintile
Income Share Tax Share Eff. Tax Rate Income Share Tax Share Eff.
Tax Rate Income Share Tax Share Eff. Tax Rate Income Share Tax
Share Eff. Tax Rate Lowest4.51.68.13.81.810.43.71.48.93.40.75.0
Second10.36.915.69.46.915.99.26.415.89.05.614.9
Third15.513.219.814.71319.214.512.519.514.512.019.7
Fourth22.522.122.921.921.921.721.721.222.121.320.222.6
Highest47.556.127.650.756.224.151.458.225.552.161.428.1 Top 10%
31.739.128.735.039.224.436.141.626.036.945.329.2 Top 5%
21.427.429.724.527.524.425.729.826.226.533.630.2 Top 1%
9.412.831.911.813.324.512.814.926.313.418.432.7 Source: Gregg
Esenwein, The Size and Distribution of the Federal Tax Burden:
1950- 1996, Report 96-386 (Washington, DC: Library of Congress,
1996) PA 546 Constantine Hadjilambrinos
Slide 9
Individual or Business Taxes? All taxes are ultimately paid by
individuals. Business taxes may be justified in certain cases:
Business tax may be more effective and/or less costly to collect.
Business tax may be necessary to internalize externalities.
Business taxes are often used instead of individual taxes for
political reasons: exporting or hiding the tax. PA 546 Constantine
Hadjilambrinos
Slide 10
Revenue Production Accounting relationship between taxes and
revenue: R = t x B Economic relationship between taxes and revenue:
R = t B(t) Economic relationship between taxes and revenue: R = t x
B(t) R = Revenue t = Tax rate B = Tax base PA 546 Constantine
Hadjilambrinos
Slide 11
Slide 12
Stability of tax system Cyclical stability of tax base Cyclical
stability of tax base Tax diversification: 1. Personal income taxes
2. Property taxes 3. General sales or value added taxes 4. Excises
5. Corporate profit taxes Revenue (adequacy) stability Revenue
(adequacy) stability Economic growth = growth in demand for
services. Need revenue sources that also expand (or contract) with
income. PA 546 Constantine Hadjilambrinos
Slide 13
Collectibility Resources used to collect taxes are costs.
Efficiency requires minimization of costs. There is usually a
trade-off between equity and collectibility. PA 546 Constantine
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Slide 14
Economic Effects 1. Work vs. leisure: High marginal rates may
induce a preference for leisure. 2. Business operations: Taxes
should not (generally) affect business practices. 3. Shopping and
business location: Sales taxes and excises may affect shopping
patterns and business location. 4. Personal financial management:
People manage activities and finances to minimize tax burden. 5.
Investment choices: Taxes may make less productive investments
preferable. 6. Savings: Taxes may adversely affect decisions to
save. PA 546 Constantine Hadjilambrinos
Slide 15
State & Local Taxes and Economic Development State and
local governments worry that taxes may adversely impact economic
development. Taxes have a relatively small effect on interregional
location. Taxes have a relatively small effect on interregional
location. Taxes have a much larger effect within a region. Taxes
have a much larger effect within a region. PA 546 Constantine
Hadjilambrinos
Slide 16
Transparency An effective tax system must be transparent
Adoption: Taxes must be adopted by legitimate process. Adoption:
Taxes must be adopted by legitimate process. Administration: Tax
collection criteria must be objective, explicit, knowable, and
fair. Administration: Tax collection criteria must be objective,
explicit, knowable, and fair. Compliance requirements: How tax is
to be calculated should be clear to everyone. Compliance
requirements: How tax is to be calculated should be clear to
everyone. Amount of payment: Taxpayers should know how much tax
they are paying and to whom they are paying it. Amount of payment:
Taxpayers should know how much tax they are paying and to whom they
are paying it. PA 546 Constantine Hadjilambrinos
Slide 17
Taxation and Externalities An exception to standard of
neutrality for tax efficiency is to address negative externalities
Emission taxes: Taxes on polluting emissions. Emission taxes: Taxes
on polluting emissions. Direct measurement of emissions necessary
Direct measurement of emissions necessary Apply to last linkwhere
emissions into environment take place Apply to last linkwhere
emissions into environment take place Indirect taxes on goods and
services: Taxes of products and services the production of which
produces social costs (pollution, health costs, social services).
Indirect taxes on goods and services: Taxes of products and
services the production of which produces social costs (pollution,
health costs, social services). PA 546 Constantine
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