Taxation

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Taxation
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Objectives of This Lecture

• Discuss the economics and nature of taxes.
• An unbiased approach.
• Assist students to see that
• Taxation is a complicated issue.
• There is no such thing as a best tax.
• Question How do we pay for public goods?

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Taxation A Brief History

• Matthew, the tax collector.
• Tax farming.
• Tax collectors sinners.
• The French
• An important cause of the French revolution.
• Contributed to the downfall of Napoleon.
• The English
• After the Glorious Revolution, Parliament
  stripped the King of the right to tax.
• The wig and powder tax.
• The United States
• The Boston tea party make is a coffee drinking
  nation.
• Our constitution specifically states who has the
  right to tax.
• The Whiskey Rebellion.

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Adam Smiths Maxims of Taxation

• Source Smith, Adam, The Wealth of Nations, The
  Modern Library, 2000, pp 888-890

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Smiths Maxims of Taxation (No.1)

• The subjects of every state ought to contribute
  towards the support of the government, as nearly
  as possible, in proportion to their respective
  abilities that is, in proportion to the revenue
  which they respectively enjoy under the
  protection of the state.
• The expense of government to the individuals
  of a great nation, is like the expense of
  management to the joint tenants of a great
  estate, who are all obliged to contribute in
  proportion to their respective interests in the
  estate.

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Smiths Maxim of Taxation (No. 2)

• The tax which each individual is bound to pay
  ought to be certain, and not arbitrary. The time
  of payment, the manner of payment, the quantity
  to be paid, ought to be clear and plain to the
  contributor, and to every other person.
• Where it is otherwise, every person subject to
  the tax is put more or less in the power of the
  tax-gatherer, who can either aggravate the tax
  upon any obnoxious contributor, or extort, by the
  terror of such aggravation, some present or
  perquisitie to himself.

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Smiths Maxim of Taxation (No. 3)

• Every tax ought to be levied at the time, or in
  the manner, in which it is most likely to be
  convenient for the contributor to pay it.
• A tax upon the rent of land or of houses, payable
  at the same term at which such rents are usually
  paid, is levied at the time when it is most for
  the likely to be convenient for the contributor
  to pay or when he is most likely to have the
  wherewithal to pay. Taxes upon such consumable
  goods as are articles of luxury, are all finally
  paid by the consumer, and generally in a manner
  that is very convenient for him.

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Smith Maxims of Taxation ( No. 4)

• Every tax ought to be so contrived as both to
  take out and to keep out of the pockets of the
  people as little as possible, over and above what
  is brings into the public treasury of the state.

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Smiths Additional Comment

• An injudicious tax offers a great temptation to
  smuggling. But the penalties of smuggling must
  rise in proportion to the temptation.
• The law, contrary to all the principles of
  justice, first creates the temptation, and then
  punishes those who yield to it and it commonly
  enhances the punishment too in proportion to the
  very circumstances which ought certainly to
  alleviate it, the temptation to commit the crime.

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Tax Features

• Smiths Tax Philosophy
• Equality.
• Certainty.
• Convenience of payment.
• Economy of collection.

• Modern Tax Philosophy
• Is distribution of the tax burden fair?
• Are taxes designed to minimize frictions or
  distortions?
• Is the system understandable to the payers?
• Is the tax system operated at as low a cost as
  possible?

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What Do We Tax

• Income.
• Wages.
• Interest and dividends.
• Consumption.
• Sales tax.
• Excise tax.
• Wealth.
• Property (Personal and real).
• Capital gains.
• Inheritance.

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What Do We Tax - Continued

• Tax base The measure of value on which a tax is
  levied. (Page 377 in text.)
• Examples
• All income after deductions above X amount.
• Federal income tax.
• The value of your home.
• County real estate tax.
• The value of your automobile.
• Personal property tax.

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Principles of Taxation

• The goal of economic efficiency.
• The benefits received principle.
• The ability to pay principle.
• The horizontal and vertical equity principles.
• The progressive and regressive tax concepts.
• The goal of attaining social objectives.

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Taxes and Economic Efficiency

• A tax is efficient if it imposes a small excess
  burden relative to the tax revenue it raises.
• Excess burden is the efficiency loss to the
  economy that results from a tax causing a
  reduction in the quantity of a good produced.
• Do high taxes discourage the start of new
  businesses?
• Do high taxes encourage people to leave the
  formal labor force?
• Do high taxes alter incentives to work, save, or
  invest?
• A tax that is neutral with respect to economic
  decisions is preferable to one that distorts
  economic dedcisions.

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Tax Efficiency Tax Burden

• We begin
• with a
• common
• supply
• and
• demand
• diagram.

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Tax Efficiency and Tax Burden, Cont.

• When we
• include the
• tax on the
• item the
• supply curve
• shifts left and
• the price
• increases.

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Tax Efficiency and Tax Burden, Cont.

• With the new
• higher price and
• the lower quantity
• demanded, we
• see that producers
• are producing less
• and receiving a
• lower price.
• Therefore, high
• taxes lead to
• lower production.

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Benefits Received Principle

• A theory of fairness holding that taxpayers
  should contribute to government (in the form of
  taxes) in proportion to the benefits that they
  receive from public expenditures. (Page 381)
• Examples
• Toll roads and bridges.
• Federal highway trust fund.
• Landing fees at an airport.
• The tax side and the expenditure side are
  connected.
• Problem How does society pay for public goods?

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Ability to Pay Principle

• A theory of taxation that holds that citizens
  should bear tax burdens in line with their
  ability to pay.
• The tax side and the expenditure side are viewed
  separately.

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Ability To Pay Principle - Continued

• Regressive tax (Page 379 in text.)
• A tax whose burden, expressed as a percentage of
  income, falls as income increases.
• Example A retail sales tax.
• Progressive tax (Page 378 in text.)
• A tax whose burdens, expressed as a percentage of
  income, increases as income increases.
• Example Individual income tax.
• Proportional tax (Page 378 in text.)
• A tax whose burden is the same proportion of
  income for all households.
• Example A flat tax.

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Ability To Pay Principal - Continued

• Horizontal equity (Page 387 in text.)
• The principle of horizontal equity holds that
  those with equal ability to pay should bear equal
  tax burden.
• Vertical equity (Page 387 in text.)
• The principle of vertical equity holds that those
  with greater ability to pay should pay more.

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Social Goals and Taxation

• There are citizens who believe that one of the
  legitimate purposes of a tax system is to promote
  social goals.
• Redistribution of income.
• John Maynard Keynes.
• Franco Modigliani.
• Promote economic growth.
• Deduction of mortgage interest on income taxes.
• Deductions for number of children on income
  taxes.
• Sin taxes.
• Liquor taxes.
• Tobacco taxes.

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Features of an Income Tax

• A tax on income.
• A tax on flow.
• Generally considered progressive.
• Contains both horizontal and vertical equity.
• An ability to pay tax.
• Generally considered to be anti-growth since tax
  payers are taxed twice.
• Types
• Federal tax A marginal tax above a certain
  level.
• Missouri Tax Marginal to a point and then
  proportional.
• City of St. Louis A proportional tax.

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Marginal Tax RatesSingle Tax Payer 2005 Rates
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Average Tax Rate
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Features of Real Estate Taxes

• A tax on stock.
• A tax on wealth.
• There is vertical equity
• Those who have the most pay the most.
• There is no horizontal equity
• The tax is not uniform city to city.
• It is an ability-to-pay tax.
• Is it regressive?
• Lower income households pay a larger percentage
  of their income.
• However, studies show that upper income people
  pay a higher percentage of their income on
  housing that do lower income people.

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Keynesian Rate/Receipts Curve
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Laffer Rate/Receipts Curve
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Supply SideTenets of Taxation

• Beyond some point, high marginal tax rates on
  personal income can reduce peoples willingness
  to work.
• High marginal tax rates discourage people from
  investing in education and improving their work
  related skills.
• High marginal tax rates encourage people to work
  in the underground economy.
• (Source Page 331, McKenzie, Richard B.,
  Macroeconomics, Houghton Mifflin Co, 1986)

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When Do Tax Cuts Matter

• (Chapter 14 in the Readings Book)

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When Do Tax Cuts Matter

• The concept of marginal utility
• As a general rule, people maximize their own
  utility
• They make choices that maximize their
  satisfaction.
• They look at the marginal cost and marginal
  benefit.
• They consider what is happening today as well as
  what they believe will happen in the future.

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When Do Tax Cuts Matter

• Therefore
• Temporary tax cuts have temporary benefits.
• Any change in behavior will be short lived.
• If the income tax is cut for next year but not
  the year after
• -gt People will work hard next year, but not
  the
• next year after that.
• Permanent tax cuts affect peoples futures, and
  they pick up on that.
• gt Permanent tax cuts affect peoples
• utility, and , therefore, their
  behavior.