12-1 An Overview of U.S. Taxation

• While taxes typically cause deadweight losses, the tax system should be efficient and equitable.

• The Gross Domestic Product (GDP) measures the total income in the economy.

• The tax revenue has grown with the government.

• The U.S.'s total government tax revenue is 26%.

Taxes Collected by the Federal Government

• The U.S. federal government collects around 2/3 of our economy's taxes.

• The personal income tax is the largest source of revenue for the federal government, making American families fill out tax forms to determine the amount of income taxes they owe to the government.

• Tax liabilities are how much a family owes based on their total income.

• The marginal tax rate is the tax rate applied to each additional dollar of income.

• Payroll taxes are taxes on the wages that a firm pays its workers.

• Social insurance taxes pay for Social Security and Medicare.

• Profit is the amount a corporation receives for goods or services it sells. This does not include the price it costs to produce these goods or services.

• Excise taxes are taxes on specific goods.

  • Ex. Gasoline, Cigarettes, Alcohol.

Taxes Collected by State and Local Governments

• State and local governments collect about 1/3 of paid taxes. They can levy personal and corporate income taxes.

• Receipts showed over $2.5 trillion in paid taxes in 2017.

• Property taxes are most important for state and local governments as they make up 21% of receipts.

12-2 Taxes and Efficiency

Deadweight Losses

• Efficient tax systems include small deadweight losses and small administrative burdens.

• Corrective taxes raise tax revenue, which can then be used to reduce taxes.

• Taxpayers have the ability to put some of their income into special savings accounts.

  • Ex. Individual Retirement Accounts and 401(k) plans.

Administrative Burden

• In early April, typically April 15, people fill out their tax forms. In order to successfully do so, one must previously have kept a record of their taxes through the year. Often, people will hire tax lawyers or accountants to help fill out their taxes, also known as legal tax avoidance.

Marginal Tax Rates versus Average Tax Rates

• Average tax rate: total taxes paid divided by total income.

• Marginal tax rate: the amount by which taxes increase from an additional dollar of income.

Lump-Sum Taxes

• Lump-sum tax: a tax that is the same amount for every person.

• Lump-sum taxes are the most efficient taxes because it does not get distorted by incentives.

12-3 Taxes and Equity

The Benefits Principle

• Benefits principle: the idea that people should pay taxes based on the benefits they receive from government services.

  • Ex. Taxes on gas are sometimes justified by the benefits principle.

Ability-to-pay Principle

• The idea is that taxes should be levied on a person according to how well that person can shoulder the burden.

• Vertical equity: the idea that taxpayers with a greater ability to pay taxes should pay larger amounts.

• Horizontal equity: the idea that taxpayers with similar abilities to pay taxes should pay the same amount.

• Proportional: a tax for which high-income taxpayers pay the same fraction of income.

• Regressive: a tax for which high-income taxpayers pay a smaller fraction of their income than do low-income taxpayers.

• Progressive: a tax for which high-income taxpayers pay a larger fraction of their income than do low-income taxpayers.

Tax Incidence and Tax Equity

• Tax incidence studies who bears the burden of taxes.

• All taxes are burdened upon the people.

12-4 Conclusion

• Tax systems require equity and efficiency.

• President Bill Clinton signed a law that raised marginal tax rates on rich Americans to around 40%.