Taxes & Government

Spending

What is a tax?• A required payment to a local, state,

or national government

Why are taxes collected?

• Taxation is the primary way that the government collects money (revenue) that is used

to provide goods and services to us.

I. The Economics of TaxationsA. Impact of Taxes

1. Resource Allocationa. When a tax is placed on a good, the cost of

production rises, the demand decreases, and the price rises.b. Production may be moved or allocated to another industry or go unused.

2. Behavior Adjustmenta. Sin Tax – a high tax designed to lower consumption of a socially undesirable product

1). Examples – liquor and tobaccob. Raises government revenue

3. Productivity and Growtha. High income taxes can cause people to lose their incentive to work.b. High income taxes can cause businesses to lose their incentive to continue their business.c. High taxes may cause people to be able to save less money.

B. Criteria for Taxes1. Equity

a. Defining the equity or fairness of a tax may be the most difficult task in creating a tax.

1). Some feel that a fair tax is when everyone pays the same amount no matter what their income is.2). Some feel that wealthier people should pay more than people with low incomes.

b. Tax Loophole1). Exception or oversight in the tax laws that allows some people and businesses to avoid paying certain taxes

2. Simplicitya. Tax laws should be written so that tax collectors as well as tax payers can understand them.b. Confusing tax forms tend to make people more apt to try to avoid paying the tax.

3. Efficiencya. The tax should be easy to administer and a good revenue generating device.b. Costs of implementing the tax should be far less than the money brought in by the tax.

C. Two Principles of Taxation1. Benefit Principle

a. Two main ideas1). Those who benefit from government services should be the ones to pay for them2). People should pay taxes proportional to the services they receive

a). Example: gasoline – those who buy gasoline benefit because the tax on gas goes to help improve roads and bridges, hence, those who buy more gas and use more roadway, will pay more in taxes.

b. Limitations1). Those who receive more benefits (usually the poor) have less means to pay into them (welfare)

2). Benefits are hard to measure

3. Ability-to-Pay Principlea. people are taxed according to their ability to pay b. people who make or save more, pay more

Types of Taxes

1. Proportional

2. Progressive

3. Regressive

Proportional Taxes

• Definition: The percentage of income paid in taxes remains the same for all income levels. – A 6% proportional income tax

• Leslie (a CEO) makes $350,000/yr and Tony (a nurse) makes $50,000/yr.

• Leslie pays 6% of her $350,000 ($21,000)• Tony pays 6% of his $50,000 ($3,000)

• Example: Income tax in Estonia, Slovakia, & other European Countries

Progressive Taxes

• Definition: The percentage of income paid in taxes increases as income increases.

• Example: U.S. federal income tax

INCOME ($) TAX (%)14,000-17,500

12 %

25,500-28,250

17 %

31,000-34,700

19 %

44,200-47,400

21 %

56,500-59,800

23 %

67,600-72,900

25 %

95,200-99,000

27 %

Regressive Taxes

• Definition: A single tax rate is applied to everyone. The percentage of income paid in taxes decreases as income increases.– Although the tax rate remains constant…– Higher-income households spend a lower

proportion of their incomes on taxable goods and services.

– The proportion of their income spent on sales taxes is lower than that of lower-income households.

• Example: Sales tax

II. The Federal Tax SystemA. Individual Income Taxes (Most important federal tax)

1. Under the 16th Amendment (1913) Congress has the “power to lay and collect taxes on incomes”2. Payroll Deductions

a. Payroll Withholding System1). An employer uses federal tax tables to estimate the amount of taxes a worker would pay on a given paycheck2). Sends that money directly to the government

a). IRS – Internal Revenue Service3). By April 15th of each year, employees must file a report with the federal government outlining their income, deductions, and taxes already paid from withholdings.

a). The difference in what is owed (determined by tax tables) must be paid by the employee.b). If the employee has paid more

than they need to, they receive a tax return.

3. A Progressive Income Taxa. Our current income tax structure is a progressive income tax

1). As you make more money, your tax rate goes upb. See income tax tables

4. Indexinga. a system used to adjust tax brackets in line with inflation

B. FICA Taxes (2nd most important federal tax)1. FICA – Federal Insurance Contributions Act2. Social Security Taxes

a. Since 1990, Social Security’s Old Age, Survivors, and Disability Insurance has been taxed at a rate of 6.2%

1). The maximum amount paid into the system stops at a $90,000 income (2005) 2). Once your income goes above $90,000, you do not pay more than $5,580, even if you make 1 million per year

b. Social Security is a proportional tax up to $90,000 in income but then becomes a regressive tax

3. Medicarea. Since January 1, 1994, Medicare has been a proportional tax at 1.45% at all income levels

C. Corporate Income Taxes (3rd most important federal tax)1. Taxes collected on the incomes made by corporations2. Tax is slightly regressive3. Corporate Income Tax Rates are much like personal rates

D. Other Federal Taxes1. Excise Tax

a. a tax on the manufacture or sale of certain itemsb. Examples: gasoline, liquor, betting (entertainment tax)

2. Estate Taxa. tax the government places on the transfer of property when a person diesb. Tax can range from 18% to 55% depending on value of estatec. Estates under a set amount by the government are exempt ($600,000 in 1995)

3. Gift Taxesa. a tax on donations of money or wealthb. paid by the person who makes the giftc. used to deter people from avoiding taxes by giving away their money before they died. makes college contributions to children’s savings accounts very

difficult4. Customs Duties

a. Tariffs: A charge levied on goods brought into the country from other countries

b. duties cover all types of products but rates are usually very low1). Duty-Free shops often seen on boarders

5. Miscellaneous Feesa. Users Fees

1). Example: Paying a fee to enter a National Park

Where do your U.S. tax dollars go?

III. State and Local Tax SystemsA. State Government Revenue Service (How do States make $)

1. Sales Taxa. a tax levied on consumer purchases b. money is the turned over to the state on either a weekly or monthly basisc. largest source of revenue for statesd. five states do not have a state sales tax

1). Delaware, Alaska, Montana, New Hampshire and Oregon

e. sales tax is rarely put on necessities such as food, clothing and prescription drugs

STATISTICS AS OF 1995

2. Intergovernmental Revenuesa. funds given to the states from the federal government for

programs such as welfare, education, highways and hospitals3. Individual State Income Tax

a. like federal income tax, states also collect a tax based on income

4. Employee Retirement Contributionsa. many states require people to pay a tax in order to cover the

costs of retirement and pension costs of state employees5. Other Revenues

a. tuition from state run colleges and universitiesb. corporate income taxes

B. Local Government Revenue Sources (How do cities, and towns make $)1. Intergovernmental Revenue

a. funds given to cities and towns from the state government for programs such as education and welfare

2. Property Taxesa. different forms of property tax includes real property tax,

tangible property tax, and intangible property taxb. real estate tax is the tax that raises the most revenue for towns

1). People are taxed based on the value of their home and property

3. Liquor Store Incomea. taxes placed on liquor sold in storesb. creates a good amount of revenue for the government

4. Sales Taxesa. Some towns may impose their own sales tax in addition to the state sales tax

5. Other Sources of Revenuea. personal income tax (local income tax)b. Occupational Privilege Tax (PA) $10-$52

C. Examining your Paycheck1. Federal, State, and Local taxes are taken out of your paycheck2. Taxes not taken out of your check that must be paid separately often include property taxes and school taxes

Gross bi-weekly pay

Year to Date Gross Pay (no taxes taken out)

8.54 % 6.2% 1.45% 3.07% 0.09%

1% 7.5% .03% 12.66%Voluntary403(b)

40.51% of pay is never seen

$822.02 for 10 days at 7.5 hours per day:

$18.42 gross pay per hour - $10.96 net pay per hour+ medical benefits

Federal Spending• Mandatory (60%): Money that lawmakers

are required by existing laws to spend on certain programs or to use for interest payments on the national debt

• Discretionary (40%): Spending about which government planners can make choices

Mandatory Spending

About 2/3 of federal revenue is spent on interest and entitlement benefits.

Discretionary Spending

About 1/3 of federal revenue is spent on discretionary spending, the largest category being defense spending.

BALANCED BUDGET: total revenue = total spending

BUDGET SURPLUS:total spending < total revenue

BUDGET DEFICIT: total spending > total revenue

Three possible budget outcomes: