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1、-12THE DESIGN OF THE TAX SYSTEMWHATS NEW IN THE SEVENTH EDITION:All tables have been updated to the most recently available numbers. A new In the News box on “Tax Expenditures has been added.LEARNING OBJECTIVES:By the end of this chapter, students should understand: how the U.S. government raises an
2、d spends money. the efficiency costs of taxes. alternative ways to judge the equity of a tax system. why studying tax incidence is crucial for evaluating tax equity. the trade-off between efficiency and equity in the design of a tax system.CONTEXT AND PURPOSE:Chapter 12 is the third chapter in a thr
3、ee-chapter sequence on the economics of the public sector. Chapter 10 addressed externalities. Chapter 11 addressed public goods and common resources. Chapter 12 addresses the tax system. Taxes are inevitable because when the government remedies an externality, provides a public good, or regulates t
4、he use of a common resource, it needs tax revenue to perform these functions.The purpose of Chapter 12 is to build on the lessons learned about taxes in previous chapters. We have seen that a tax reduces the quantity sold in a market, that the distribution of the burden of a tax depends on the relat
5、ive elasticities of supply and demand, and that taxes cause deadweight losses. We expand the study of taxes in Chapter 12 by addressing how the U.S. government raises and spends money. The difficulty of making a tax system both efficient and equitable is then discussed.KEY POINTS: The U.S. governmen
6、t raises revenue using various taxes. The most important taxes for the federal government are individual income taxes and payroll taxes for social insurance. The most important taxes for state and local governments are sales taxes and property taxes. The efficiency of a tax system refers to the cost
7、s it imposes on taxpayers. There are two costs of taxes beyond the transfer of resources from the taxpayer to the government. The first is the deadweight loss that arises as taxes alter incentives and distort the allocation of resources. The second is the administrative burden of complying with the
8、tax laws. The equity of a tax system concerns whether the tax burden is distributed fairly among the population. According to the benefits principle, it is fair for people to pay taxes based on the benefits they receive from the government. According to the ability-to-pay principle, it is fair for p
9、eople to pay taxes based on their capability to handle the financial burden. When evaluating the equity of a tax system, it is important to remember a lesson from the study of tax incidence: The distribution of tax burdens is not the same as the distribution of tax bills. When considering changes in
10、 the tax laws, policymakers often face a trade-off between efficiency and equity. Much of the debate over tax policy arises because people give different weights to these two goals.CHAPTER OUTLINE:I.A Financial Overview of the U.S. GovernmentFor this material to be relevant, you will want to update
11、it from time to time. Data on government receipts and expenditures can be found easily on the Internet or through the most recent edition of the Economic Report of the President.A.Figure 1 shows the level of government revenue in the United States, including federal, state, and local governments, as
12、 a percentage of total income for the U.S. economy.Figure 11.The role of government has grown substantially over the past century.2.The governments revenue from taxation has grown at a faster rate than the economys level of income.B.Table 1 compares the tax burden for several major countries, as mea
13、sured by the governments tax revenue as a percentage of the nations total income.Table 11.The United States has a low tax burden compared to most other advanced economies.2.Many European nations have much higher taxes, which finance a more generous social safety net. C.The Federal Government1.Receip
14、tsa.Table 2 reports the receipts of the federal government in 2011.Table 2b.Total receipts were $2,520 billion or $8,077 per person.c.The largest source of revenue is the individual income tax.d.A familys income tax liability is how much it owes in taxes based on income. This tax is not proportional
15、 to income. It is based on income minus deductions, and the tax rate rises as income rises. Table 3 presents federal tax rates for 2013.Table 3e.Other important revenue sources include payroll taxes (social insurance taxes), the corporate income tax, and excise taxes.2.Spendinga.Table 4 reports wher
16、e the federal government spent its budget in 2011.Table 4b.Total spending was $3,757 billion or $12,042 per person.c.The largest category of expenditure is for income security, which includes Social Security, unemployment insurance payments, and welfare payments. The second largest expense is health
17、 programs, including Medicare, Medicaid, and spending on medical research.d.The next largest category of spending is national defense. e.Another important category of expenditure is net interest on the federal debt.3.Definition of budget deficit: an excess of government spending over government rece
18、ipts.Activity 1Alphabet Soup: The Role of the GovernmentType:In-class assignmentTopics: The role of governmentMaterials needed: NoneTime: 15 minutesClass limitations: Works in any size class4.Definition of budget surplus: an excess of government receipts over government spending.PurposeThis assignme
19、nt shows that many government activities exist in a market economy. InstructionsAsk the students to list as many government-provided goods and services as possible. They should include activities at the federal, state, and local levels.Then ask them to list all the “alphabet” agencies (FBI, CIA, USD
20、A, etc.).The most important question to ask is “WHY?” Why, in a predominantly market economy, does the government play so many roles?Common Answers and Points for DiscussionStudents should be able to list dozens of government activities and nearly as many agencies.The rationale for government action
21、 can include: Creating an institutional framework for markets (laws, courts, money, SEC) Addressing market failure (national defense, education, highways, EPA) Addressing monopoly (antitrust, public utilities, FTC) Addressing equity and income distribution (Social Security, food stamps) Macroeconomi
22、c stability (fiscal policy, monetary policy) Financing the above activities (taxes, bonds, IRS).D.Case Study: The Fiscal Challenge Ahead1.From 2009 to 2012, the U.S. federal government had budget deficits that exceeded $1 trillion every year, the largest budget shortfalls since World War II.2.Long-t
23、erm projections of the governments budget show that this is expected to rise dramatically in the decades ahead.Figure 2a.The population ages 65 and older is growing; thus, Medicare and Social Security expenditures will rise as well.b.In addition, the costs of Medicare, Medicaid and government-subsid
24、ized health insurance are affected by the rising cost of medical care.E.State and Local Government1.ReceiptsTable 5a.Table 5 reports the receipts from state and local governments for 2011.b.Total receipts were $2,064 billion or $6,615 per person.c.The two most important taxes for state and local gov
25、ernments are sales taxes and property taxes.d.State and local governments also levy individual and corporate income taxes.e.State governments also receive funding from the federal government.2.Spendinga.Table 6 shows how state and local governments spent their budgets in 2011.Table 6b.The largest ca
26、tegory of spending was education, while the second largest category was health programs.II.Taxes and EfficiencyA.Well-designed tax policies minimize the deadweight losses that occur when taxes distort incentives. They also minimize the administrative burdens that taxpayers face when complying with t
27、ax laws.B.Deadweight Losses1.Taxes lead to deadweight losses because they lower total surplus.Provide students with several examples of how taxes lead to an inefficient outcome. Some examples to discuss include an inefficient shifting of productive activity from the market sector to the household se
28、ctor, diminished saving, and increased leisure.2.Case Study: Should Income or Consumption Be Taxed?a.Because interest income is taxed, the current income tax laws discourage saving.b.If consumption (instead of income) is taxed, this disincentive disappears.c.European nations tend to rely more on con
29、sumption taxes than does the United States.C.Administrative Burden1.The current tax system is quite burdensome because of the large amount of paperwork required both when filling out tax forms and keeping records throughout the year.For most undergraduate students, this burden may seem somewhat triv
30、ial. Use some real-world examples of actual compliance costs to underscore this important aspect of taxation. Use some personal examples if appropriate.2.Many taxpayers spend resources hiring accountants and tax lawyers.a.People often need help filling out complex tax forms.b.Individuals may also wa
31、nt to learn how to arrange their affairs to reduce their tax burden.D.Marginal Tax Rates versus Average Tax Rates1.Definition of average tax rate: total taxes paid divided by total income.2.Definition of marginal tax rate: the amount that taxes increase from an additional dollar of income.3.The aver
32、age tax rate measures the sacrifice made by a taxpayer; the marginal tax rate measures how much the tax system distorts incentives.ALTERNATIVE CLASSROOM EXAMPLE:Income = $100,000Tax BracketsTax Rate:$0$20,0000%$20,001$50,000 15%$50,001 +25%Tax liability = (0.15)($30,000) + (0.25)($50,000)= $4,500 +
33、$12,500 = $17,000Average tax rate = $17,000/$100,000 = 17%Marginal tax rate = 25%E.Lump-Sum Taxes1.Definition of lump-sum tax: a tax that is the same amount for every person.2.For this type of tax, the marginal tax rate is equal to zero.3.This is the most efficient type of tax because it does not di
34、stort incentives and thus has no effect on total surplus. There is also little administrative burden with this type of tax.4.However, a lump-sum tax would take the same amount from the poor and the rich, which most people would view as unfair.III.Taxes and EquityA.The Benefits Principle1.Definition
35、of benefits principle: the idea that people should pay taxes based on the benefits they receive from government services.2.This principle tries to make public goods similar to private goods.3.An example of this would be the tax on gasoline, especially if revenues from the tax are used to build or ma
36、intain roads.B.The Ability-to-Pay Principle1.Definition of ability-to-pay principle: the idea that taxes should be levied on a person according to how well that person can shoulder the burden.2.Definition of vertical equity: the idea that taxpayers with a greater ability to pay taxes should pay larg
37、er amounts.Table 7a.Three tax systems: proportional, regressive, and progressive.b.Definition of proportional tax: a tax for which high-income and low-income taxpayers pay the same fraction of income.c.Definition of regressive tax: a tax for which high-income taxpayers pay a smaller fraction of thei
38、r income than do low-income taxpayers.d.Definition of progressive tax: a tax for which high-income taxpayers pay a larger fraction of their income than do low-income taxpayers.e.Case Study: How the Tax Burden Is Distributed Table 8 shows that the tax burden in this country is highly progressive. In
39、addition, studies have shown that, if transfer payments are also taken into account, the degree of progressivity is substantial.Table 83.Definition of horizontal equity: the idea that taxpayers with similar abilities to pay taxes should pay the same amount.C.Tax Incidence and Tax Equity1.The burden
40、of a tax is not always borne by who pays the tax bill.2.Example: tax on fur coats. This will ultimately affect those who sell and produce the fur coats because the quantity of fur coats demanded will fall due to the increase in price.3.Case Study: Who Pays the Corporate Income Tax?a.The corporate in
41、come tax is popular among voters because a corporation is nonhuman and faceless.b.However, the burden of the corporate tax falls on stockholders, customers, and workers.c.An increase in corporate taxes means an increase in the cost of producing the product. Firms will cut back production (which lowe
42、rs supply and raises the price to the consumer) and possibly lay off workers (which causes unemployment, lower wages, or both).D.In the News: Tax Expenditures1.Eliminating tax expenditures, special tax cuts for things like mortgage interest and charitable giving, could result in lower taxes and fisc
43、al sustainability.2.This article from The New York Times discussing the benefits of eliminating tax expenditures and the politics associated with such a proposal.IV.Conclusion: The Trade-off between Equity and EfficiencyActivity 2Tax AlternativesType:In-class assignmentTopics: Taxes and fairnessMate
44、rials needed: NoneTime: 20 minutesClass limitations: Works in any size classPurposeThe impact of taxes can be examined in a variety of ways. This exercise helps students think about the different effects of taxes on different goods. Taxes that may be appealing because they minimize deadweight loss m
45、ay be undesirable for equity reasons.InstructionsTell the class, “The state has decided to increase funding for public education. They are considering four alternative taxes to finance these expenditures. All four taxes would raise the same amount of revenue.” List these options on the board: 1.A sa
46、les tax on food2.A tax on families with school-age children3.A property tax on vacation homes4.A sales tax on jewelryAsk the students to answer the following questions. Give them time to write an answer, then discuss their answers before moving to the next question:A.Analyze these taxes using the be
47、nefits principle.B.Analyze these taxes using the principle of horizontal equity.C.Classify each tax as progressive, proportional, or regressive.D.Which tax would you choose to finance education? Explain.Common Answers and Points for DiscussionA. Are the taxes related to the benefits received?1.A sales