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Wrapping up taxation
Today: Studying taxation graphically
The US Personal Income Tax
The marriage penalty
Problem 1a
OH
OM
.8
.6
$
16,000
18,000
DM
DH
Note that shares are on the vertical axis, and that the upward-sloping line has a vertical intercept of 0.6 relative to OH. Full credit required that the intercepts were properly labeled.
Megan’s share is 0.8 – Q/20,000 and Haley’s share is 0.6 – Q/30,000.
Problem 5b
Bjorn has just broken his hip and will require a trip to the hospital
The total cost of being in the hospital is 20,000Q; his total benefit of being in the hospital is 100,000Q – 5,000Q2
How long will Bjorn want to stay in the hospital if he must pay a $60,000 co-payment for his hospital stay? Note that MB of 1st day is higher than his co-payment
Bjorn will decide to enter the hospital After the co-payment is made, Bjorn’s MC is zero Set Bjorn’s MC equal to his MB
0 = 100,000 – 10,000Q Q = 10
Problem 6b
Assume that you work 40 hours per week, and that your hourly wage is $8 per hour
U(H,E) = HE4
Each unemployed person receives $100 per week in public health care; for the first $400 earned, $0.25 in public health care is lost for each dollar earned Thus, for anybody earning more than $400, no
public health care funds are received.
Problem 6b
For someone unemployed, only $100 in public health care is consumed; for the first 40 hours worked, the person earns $8 but loses $2 in public health care Net gain per hour worked is $6 Thus, working 40 hours leads to total
consumption of $100 + $6 * 40 = $340. Then, solve the same way as in part (a),
except use $340 instead of $320: E = $272, H = $68
Changes in consumption due to taxes Recall that people typically consume less of a
good or service once it is taxed Example: Yacht tax in the early 1990s
Tax on yachts over $100,000 purchased in the US People bought yachts in other countries Net economic impact
$16.6 million in taxes collected (less than the $31 million predicted)
Less income tax paid by workers (7,600 jobs lost in the US)
Study of taxation graphically Individual behavior Excess burden in a market with horizontal
supply Taxes on labor Subsidies Pigouvian taxes
How do taxes affect individual behavior?
Pou
nds
of c
orn
per
year
Pounds of barley per year
E1
B1
C1
DF
A
Cb
Ca
B0
E2
iii
G
Market excess burden, horizontal supply
Pounds of barley per year
Pric
e pe
r po
und
of b
arle
y
a
Db
Sb
q1q2
ih
S’b
Pb
(1 + tb)Pb g f
d
Tax revenues
Excess burden of tax
Remember: Excess burden and deadweight loss mean the same thing
Subsidies lead to excess burden, too
Housing services per year
Pric
e pe
r un
it o
f h
ousi
ng s
ervi
ces
m
Dh
Sh’
h2h1
uq
Sh
(1 – s)Ph
Ph
n o
r
Excess burden
v
Recall: Pigouvian taxes reduce excess burden
Q per year
$
MB
0
MD
MPC
MSC = MPC + MD
Q1Q*
c
d
(MPC + cd)
Pigouviantax revenues
i
j
Recall double dividend hypothesis Industry with negative externality
Pigouvian tax Reduces excess burden If tax proceeds are used to reduce other
taxes, excess burden from these taxes are lowered
Criticism: An environmental tax could lead to an increase in the excess burden in the labor market
An economist’s analysis
Given an amount of revenue that is generated, taxes should be imposed such that one of the following goals is achieved Excess burden is minimized Social welfare is maximized
The real world
Taxes are often imposed that have the lowest amount of political resistance
Excess burden seems less important than revenue generation Sometimes efficiency is completely ignored
The US Personal Income Tax About 45% of federal revenues are generated
through personal income taxes Federal taxes are easy and simple to
understand, right?
Digesting federal income tax liability Tax Base- “Above-the-line” deductions
Adjusted Gross Income
- Exemptions- Larger of standard deduction or itemized deductions
Taxable Income• tax rate
Tax liability before credits- Tax credits
Regular tax liability
Wages and compensation, interest, dividends, capital gain (or loss), business income (or
loss), pensions, farm income (or loss), rents, royalties, Social
Security benefits, etc.
Trade or business expenses, moving expenses, educator
expenses, self-employed health insurance premium
payments, student loan payments, tuition and fees,
alimony paid, etc.
Phase-out with income
Charitable contributions, home mortgage interest, state and
local taxes, medical expenses in excess of 7.5% of AGI,
casualty and theft losses, non-reimbursed employee
expenses; Phase out with income; Differs by filing status
Six ordinary rates (10%, 15%, 25%, 28%, 33%, 35%);
differs by filing status; special
rates for dividends and capital gains
Child tax, additional child tax, EITC, HOPE and Lifetime Learning,
electric vehicles, health coverage tax, adoption, mortgage interest, retirement savings contribution, child and dependent care credit,
credit for the elderly or the disabled, D.C. First-Time
homebuyer’s credit, etc.; Phase-out with income
Start over to determine AMT tax liability using AMT base. Pay tentative AMT liability in excess of regular tax liability
Pay tax or claim refund
Other features of the US tax system Exemptions
$3,300 per family member is 2006 Deductions
Standard deduction $5,150 per single filer in 2006 $10,300 per joint filer in 2006 Fixed amount, no documentation needed
Itemized deductions Unreimbursed medical expenses above 7.5% of AGI State and local income and property Taxes Certain interest expenses Charitable contributions
More on simplicity
The Tax Reform Act of 1986 (TRA86) tried to simplify the tax system Increased standard deduction
Fewer people needed to itemize deductions Personal exemption increased substantially Fewer
people needed to file tax returns
Since 1986 Tax laws became more complicated About 15,000 changes to the tax code
More on simplicity
Is the tax code too complex? Some support a flat income tax
Same tax rate to everyone and each component of income
No deductions Little room for personal exemptions and business
expenses Criticism of flat income tax
Move tax burden from rich to middle class
Marginal tax rates
Official Statutory Tax Rate Schedule (2006)
Single Returns Joint ReturnsTaxable Income Marginal
Tax RateTaxable Income Marginal
Tax Rate
$0-$7,550 10% $0-$15,100 10%
$7,550-$30,650 15 $15,100-$61,300 15
$30,650-$74,200 25 $61,300-$123,700 25
$74,200-$154,800 28 $123,700-$188,450 28
$154,800-$336,550 33 $188,450-$336,550 33
$336,550 and over 35 $336,550 and over 35
Source: http://www.irs.gov/formspubs/article/0,,id=150856,00.html
Marginal tax rates
Official Statutory Tax Rate Schedule (2007)
Single Returns Joint ReturnsTaxable Income Marginal
Tax RateTaxable Income Marginal
Tax Rate
$0-$7,825 10% $0-$15,650 10%
$7,825-$31,850 15 $15,650-$63,700 15
$31,850-$77,100 25 $63,700-$128,500 25
$77,100-$160,850 28 $128,500-$195,850 28
$160,850-$349,700 33 $195,850-$349,700 33
$349,700 and over 35 $349,700 and over 35
Source: http://www.irs.gov/formspubs/article/0,,id=164272,00.html
Inflation issues
Notice that the ranges on the marginal tax rate tables increase from year to year About 3.5-4% from 2006-2007 tax years Increases account for inflation
Taxes are on real income, so to speak
Alternative minimum tax (AMT) Not adjusted for inflation More Americans are
subject to the AMT each year What used to be a policy on the rich, is now a
policy on many upper-middle income Americans
The marriage penalty
We examine the marriage issue further There are many reasons that people in the
United States decide not to marry Costly to divorce if the marriage does not work out
well Many low-income people may lose benefits
People receiving public assistance may lose qualification for these programs if they marry someone who is working
Tax burden may increase as a married couple than as if they lived together unmarried
Example of the marriage penalty: Taxes Suppose a simple case
Only taxable income determines taxes that have to be paid
See what happens to tax burden when some couples get married
Recall marginal tax rates, 2007
Official Statutory Tax Rate Schedule (2007)
Single Returns Joint ReturnsTaxable Income Marginal
Tax RateTaxable Income Marginal
Tax Rate
$0-$7,825 10% $0-$15,650 10%
$7,825-$31,850 15 $15,650-$63,700 15
$31,850-$77,100 25 $63,700-$128,500 25
$77,100-$160,850 28 $128,500-$195,850 28
$160,850-$349,700 33 $195,850-$349,700 33
$349,700 and over 35 $349,700 and over 35
Source: http://www.irs.gov/formspubs/article/0,,id=164272,00.html
Example 1, single
Cameron has $80,000 in taxable income Tax burden: $16,510.75 total
10% of $7,825 15% of $24,025 25% of $45,250 28% of $2,900
Erin has $80,000 in taxable income Tax burden: $16,510.75 total
10% of $7,825 15% of $24,025 25% of $45,250 28% of $2,900
Official Statutory Tax Rate Schedule (2007)
Single Returns Joint Returns
Taxable Income
Marginal Tax Rate
Taxable Income
Marginal Tax Rate
$0-$7,825 10% $0-$15,650 10%
$7,825-$31,850
15 $15,650-$63,700
15
$31,850-$77,100
25 $63,700-$128,500
25
$77,100-$160,850
28 $128,500-$195,850
28
$160,850-$349,700
33 $195,850-$349,700
33
$349,700 and over
35 $349,700 and over
35
As single people, Cameron and Erin pay a total of $33,021.50 in taxes
Example 1, married
Cameron and Erin get married
Total taxable income is $160,000 Tax burden: $33,792.50
total 10% of $15,650 15% of $48,050 25% of $64,800 28% of $31,500 $771 more than the total
paid if they are single
Official Statutory Tax Rate Schedule (2007)
Single Returns Joint Returns
Taxable Income
Marginal Tax Rate
Taxable Income
Marginal Tax Rate
$0-$7,825 10% $0-$15,650 10%
$7,825-$31,850
15 $15,650-$63,700
15
$31,850-$77,100
25 $63,700-$128,500
25
$77,100-$160,850
28 $128,500-$195,850
28
$160,850-$349,700
33 $195,850-$349,700
33
$349,700 and over
35 $349,700 and over
35
Example 2, single
Pat has $30,000 in taxable income Tax burden: $4,108.75 total
10% of $7,825 15% of $22,175
Shannon has $200,000 in taxable income Tax burden: $52,068.25
total 10% of $7,825 15% of $24,025 25% of $45,250 28% of $83,750 33% of $39,150
Official Statutory Tax Rate Schedule (2007)
Single Returns Joint Returns
Taxable Income
Marginal Tax Rate
Taxable Income
Marginal Tax Rate
$0-$7,825 10% $0-$15,650 10%
$7,825-$31,850
15 $15,650-$63,700
15
$31,850-$77,100
25 $63,700-$128,500
25
$77,100-$160,850
28 $128,500-$195,850
28
$160,850-$349,700
33 $195,850-$349,700
33
$349,700 and over
35 $349,700 and over
35
As single people, Pat and Shannon pay a total of $56,177 in taxes
Example 2, married
Pat and Shannon get married
Total taxable income is $230,000 Tax burden: $55,100 total
10% of $15,650 15% of $48,050 25% of $64,800 28% of $67,350 33% of $34,150 $1,077 less than the total
paid if they are single
Official Statutory Tax Rate Schedule (2007)
Single Returns Joint Returns
Taxable Income
Marginal Tax Rate
Taxable Income
Marginal Tax Rate
$0-$7,825 10% $0-$15,650 10%
$7,825-$31,850
15 $15,650-$63,700
15
$31,850-$77,100
25 $63,700-$128,500
25
$77,100-$160,850
28 $128,500-$195,850
28
$160,850-$349,700
33 $195,850-$349,700
33
$349,700 and over
35 $349,700 and over
35
Example 1: Cameron/Erin, $80K each
Official Statutory Tax Rate Schedule (2007)
Single Returns Joint ReturnsTaxable Income Marginal
Tax RateTaxable Income Marginal
Tax Rate
$0-$7,825 10% $0-$15,650 10%
$7,825-$31,850 15 $15,650-$63,700 15
$31,850-$77,100 25 $63,700-$128,500 25
$77,100-$160,850 28 $128,500-$195,850 28
$160,850-$349,700 33 $195,850-$349,700 33
$349,700 and over 35 $349,700 and over 35
More income is taxed in the 28% bracket after they get married
Example 2: Pat $30K/Shannon $200K
Official Statutory Tax Rate Schedule (2007)
Single Returns Joint ReturnsTaxable Income Marginal
Tax RateTaxable Income Marginal
Tax Rate
$0-$7,825 10% $0-$15,650 10%
$7,825-$31,850 15 $15,650-$63,700 15
$31,850-$77,100 25 $63,700-$128,500 25
$77,100-$160,850 28 $128,500-$195,850 28
$160,850-$349,700 33 $195,850-$349,700 33
$349,700 and over 35 $349,700 and over 35
As a married couple, less income is taxed in the 28% and 33% brackets; more in the 25% bracket
Two reasons that this happens When there is one person
that earns almost all of the income, more money is usually subject to the lower marginal rates Notice that the two lowest
brackets vary by a factor of two
At the higher brackets, the income ranges converge Notice that the 35% bracket
is the same whether or not you are married
Official Statutory Tax Rate Schedule (2007)
Single Returns Joint Returns
Taxable Income
Marginal Tax Rate
Taxable Income
Marginal Tax Rate
$0-$7,825 10% $0-$15,650 10%
$7,825-$31,850
15 $15,650-$63,700
15
$31,850-$77,100
25 $63,700-$128,500
25
$77,100-$160,850
28 $128,500-$195,850
28
$160,850-$349,700
33 $195,850-$349,700
33
$349,700 and over
35 $349,700 and over
35