TAX EXAM 1

tax

payment required by a government that is unrelated to any specific benefit or service received from the government

• payment required

• payment imposed by government agency

• payment not tied directly to benefit received by the taxpayer

3 key components of a tax

taxpayer

any person or organization that pays tax (writes the check) includes individuals and corporations

incidence

entity that bears the ultimate economic burden of a tax (consumer)

jurisdiction

level of government with the right to tax

internal revenue code

income - deductions

for income tax accounting:

• source of rules:

• taxable income =

base x rate = tax

general tax formula

tax base

what is taxed, and is usually expressed in monetary terms (taxable income, purchase amounts, property values, etc)

tax rate

• determined by law and determines the level of taxes imposed on the tax base and is generally expressed as a percentage

• can vary with the size of the tax base depending on the tax rate structure (graduated taxes using tax brackets vs flat tax)

income tax

tax where base is income

employment tax/social security/fica

tax where base is compensation income

• paid by employer and employee- unemployment tax paid by employer

sales/use tax

tax where base is products

• excise tac is levied on specific product

transfer tax

tax where base is transfer of wealth (estate and gift)

property tax

tax where base is value of property

implicit tax

the increased pre tax price paid to receive a tax benefit

proportional tax rate

imposes a constant tax rate throughout the tax base

progressive tax rate

imposes an increasing marginal tax rate as the tax base increases

regressive tax rate

imposes a decreasing marginal tax rate as the tax base increases

average tax rate

the tax payers average level of taxation on each dollar of taxable income

total tax / taxable income

average tax rate =

effective tax rate

the taxpayer’s average rate of taxation on each dollar of total income (both taxable and nontaxable)

total tax / total income

effective tax rate =

marginal tax rate

the tax rate that applies to the next additional dollar of a taxpayers taxable income

change in total tax / change in taxable income

marginal tax rate =

pre tax return x (1 - marginal tax rate)

after tax return =

sufficient

evaluating tax systems:

enough revenue to meet the needs of the government

equitable/fair

evaluating tax systems:

how the tax burden is distributed across taxpayers

convenient

evaluating tax systems:

system should be designed to be collected without undue hardship to the taxpayer

certain

evaluating tax systems:

taxpayers should be able to determine when/where to pay the tax and how to calculate the tax

economy

evaluating tax systems:

should minimize the compliance costs assosciated with the system

efficient

evaluating tax systems:

has the intended effect on taxpayer behavior

static forecasting

revenue forecasting that ignores how taxpayers might alter their activities in response to a tax law change and instead bases projected tax revenues on the existing state of transactions

dynamic forecasting

forecasting that tries to predict possible responses by taxpayers to new tax laws

income effect

as tax rates go up, people will work harder to maintain the same after tax income. generaly applies to lower income

substitution effect

as tax rates go up, people will substitute nontaxable activities because the marginal value of taxable ones has decreased. generally, applies to higher income

equitable

a tax system is considered _____ if based on the taxpayers ability to pay

horizontal equity

taxpayers in similar situations pay the same tax

vertical equity

taxpayers with a greater ability to pay tax pay more tax relative to taxpayers with a lesser ability to pay tax

classical standard of efficiency

a tax is efficient if it is neutral in its effect on the market. it does not distort the market, create suboptimal allocation of goods/services, or modify taxpayer behavior

keynesian/modern standards

a tax is efficient if it is an effective fiscal policy tool for regulating the economy and affecting taxpayer behavior