Ch1 Tax Intro to tax

What is tax?

A payment that is required (not valuation), imposed by a government agency and is not tied directly to a benefit that is only for that taxpayer.

How to calculate a tax?

Tax base x tax rate = tax

The three types of tax rates used

Average Tax Rate

Effective Tax Rate

Marginal Tax Rate

What is Average Tax Rate?

The average level of taxation per dollar of taxable income.

Calculation: Total tax / Taxable Income = Average Tax rate

What is Effective tax rate?

Is the average level of taxation per dollar of total / economic income.

Total tax / Total Income = Effective Tax Rate

what is the marginal tax rate?

The tax rate that applies to the next additional increment of a taxpayers taxable (or deductions)

The change in total tax / change in taxable income = Marginal tax rate

(New total tax = Old Total tax) / (New taxable Income - Old taxable income)

Ex: Chuck a single taxpayer earns $75,000 in taxable income city of Heflin bonds (use the tax rate). What is his marginal tax rate on this income?

If it was deductions (subtract) = 75,000 + 40,000 = $115000 → Use etax shedule falls below 24%

Taxable before 40,000 = 75,000

4. Taxable Income on 75,000 = 11,414

(2) - (4)

(1) - (3)

[20447-11414]/[115,000-75,000] = 9033/40,000 = Marginal Tax Rate = 22.58%

Different types of Income are Accounting Income, Total Income or Economic Income. and taxable Income

Accounting Income: based on GAAP. Fines or penalities are considered when calculating accounting Income

Total Income or Economic Income: includes opportunity costs

Taxable Income: based on tax codes and regulations a company cannot reduce it’s taxable income by including fines or penalties it pays to thegovernment.

What are the types of Federal Taxes: Income taxes, Employment and unemployment taxes, Excise taxes, Estate and Gift taxes.

Income Taxes is represented about 61% of all tax revenues collected in the U.S. in 2017 (individuals 50% + corporation 11%). Levied on Individuals, Corporations, estates and trusts

Employment and Unemployment taxes: tax base (employee wages)

- Second largest group of taxes imposed by the U.S. government

- FICA, Social security medicate

- Employer typically pays half of social security and medicate and employees pay the other half

- However, self-employed pay both the individual and the employers side of the tax

Excise taxes

- Third largest group of taxes imposed by the U.S. gov

- Levied on the quantity of products sold

- Tax Base: per gallons of gasoline

Excise Taxes

- Levied on the fair market value of wealth transfer upon death or by gift

- Tax base: the value of the gift

Ex: your grandma gives you $20,000 towards a new car your neighbor forgives a $3,000 loan he made you

Types of state and local taxes: Income taxes, sales and use taxes, and property taxes

Income Taxes: (a bit than 50% of state tax revenues)

- Largely conform to the federal taxable income

calculations with a limited number of modifications

Sales and Use taxes:

- Tax base for a sales tax is the retail sales of goods and some services]

- Tax base for the use tax is the retail price of goods owned, possessed or consimed within. a state that were not purchased within the state

Ex: buy a shirt in a state with no sales tax but bring it to where you live in a state with a use tax

Property taxes: Tax based on value of property.

- Real property taxes consists of taxes on land structures permanently attached to land (like a house you own)

- Personal property taxes consists of taxes on land and structure permanently attached to land like a house you own.

- Personal property taxes includes taxes on all other types of property both tangible and intangible (see a car)

What is the five criteria to evaluate a tax system?

1. Sufficiency

2. Equity

3. Certainty

4. Convenience

5. Economy

1. Sufficiency is enough revenues to pay for governmental expenditures

Ex: many state governments revenue balanced budgets. In reality it’s rough because sufficiency is if you need more revenue to remove a deficit why not just raise taxes until you have enough?

Because people respond to tax increases and this can affect the tax base: Think in the extreme if you had income tax increase to 20% to 100% would you work more or less?

Substitution effect: means you work less and it would reduce tax revenue. This is part of the rational for the Laffer curve graphic.

Income effect: Maybe you’d work more to have the same after tax income this is called the income effect.

2. Equity is related to fairness of the tax burden: distribute fairly across taxpayer

Horizontal equity: two tax payers in similar situations pay the same tax

Vertical equity: when taxpayers of greater ability to pay more than taxpayers with less ability to pay.

There are two approaches to vertical equity:

- In terms of dollars goes to someone who makes more and pay more tax dollars to the government

- In tax rate (x) terms does a higher proportion or (%) of a higher income earner to the government

3. Certainty (should be able to determine when to pay tax where to pay tax and how much tax is due (April 15th)

But what amount? is the amount of tax benefit or cost certain?

Ex: Tax benefit for research and development

4. Economy (should minimize the compliance and administration costs associated with the tax systems)

Remember why the tax came about to fund government provisions of public goods/services to taxpayers

Ex: defense contract enforcements. Administration costs are not part of these public goods services,

They are simply the means needed to obtain revenue needed for the government prouded goods and or services. It say it takes $1 to pay and IRS agent to collect $0.50 tax revenue. Then it’s not worth it. This is why the IRS doesn’t audit entry single taxpayer.