to the

1
Chapter 1

• Introduction
• to the
• Federal Tax System

2
Characteristics of a Tax

• A tax is
• nonpenal
• compulsory
• a transfer of resources from the private to the
  public sector
• based on predetermined criteria
• and has a specific economic and social objective

3
Tax Revenues Are ApproximatelyEqual to
Government Expenditures
TAX REVENUES GOVT SPENDING
Tax Revenues (Tax Base - Tax Expenditures)(Tax
Rate)

• Tax Expenditures are
• deductions
• credits
• exclusions

4
Technical Definitions

• Tax Base x Rate or R T/B
• Proportional Tax (flat rate)
• R stays same for all values of B
• ex Sales tax Property tax
• Progressive Tax
• R varies directly with B
• ex Income tax Estate and gift taxes
• Regressive Tax
• R varies inversely with B
• ex NONE

5
Popular Definitions
Progressive and Regressive Tax Rates

Aggregate Tax Liability
Some measure of ability to pay (e.g., personal
income)

• Progressive R varies directly with the ability
  to pay
• Regressive R varies inversely with ability to
  pay

6
Popular Definition
EXAMPLE
Smiths (Family of 2)
Jones (Family of 2)
Each house is worth 50,000 Tax rate is 20/1000
valuation

• 20,000 Annual Income 45,000
• 15,000 Cost of Living for 2 15,000
• 5,000 Discretionary Income 30,000
• 1,000 Property Tax 1,000
• 5 Tax as a of income 2.2

Thus a regressive tax
7
More Tax Rate Terms
Marginal Tax Rate
Tax rate on last of income
Average Tax Rate
Effective Tax Rate
8
2000 Example

• TP, single, 80,000 taxable income plus 100,000
  income from tax-exempt bonds
• 2000 tax 13,896.50 (31)(80,000 - 61,400)
• 19,481
• Marginal tax rate 31
• Average tax rate 19,481 24.35
• 80,000
• Effective tax rate 19,481 10.82
• 180,000

9
Tax Bases

• Income
• ordinary income
• employment
• excess profits
• Value Added Tax (VAT)
• Ad Valorem (wealth taxes)
• Wealth Transfers

• Transactions
• sales use
• excise
• special transactions
• Other
• customs
• franchise taxes
• export taxes
• head taxes

10
SECA TAXES

• Self-Employed Contributions Act (SECA)
• Imposed on SE taxpayers(TPs)
• Rates
• Twice FICA rates
• Same income limits as FICA

11
Social Security Taxes

• Levied on wages and SE income
• Two types
• FICA
• SECA

12
FICA TAXES

• Two parts
• Old Age Survivors and Disability Insurance
  (OASDI)
• Medicare Hospital Insurance (MHI)
• Rates
• OASDI for 2000, 6.2 on first 76,200 of income
• The income amount is indexed annually for
  inflation
• MHI 1.45 on all wages

13
FICA TAX levied on both

• Employers
• Employees
• Employer withholds FICA tax and pays to government

14
2000 Example

• Betty has taxable income from wages of 80,000.
• Her FICA tax is
• 1.45 TIMES 80,000 1,160
• 6.2 TIMES 76,200 4,724
• Total 5,884

15
FUTA (UNEMPLOYMENT) Taxes

• 6.2 on the first 7,000 of wages
• Imposed only on the employer
• Coordinated with state unemployment taxes

16
Special Treatment for SE TPs

• In computing income taxes, self-employed (SE)
  taxpayers (TP) deduct 1/2 of SE taxes actually
  paid
• In computing SECA tax, deduct 1/2 combined SECA
  rate (15.3 TIMES 1/2 7.65) from NE from SE

17
Tax Bases by Level of Government
18
Considerations that AffectEnactment of Tax Laws

• Economic
• stimulate savings and investment
• encourage certain industries
• stimulate small business development
• enhance US competitive position
• Social
• Equity
• wherewithal-to-pay
• alleviation of effects of
• annual accounting periods
• multiple taxation
• Political

19
Criteria for Selection of a Tax Base

• Adam Smiths Cannons of Taxation
• Equitable
• Convenient
• Certain
• Economical
• Other Criteria
• Productivity
• Effective socially and economically
• Favorable public opinion

20
Unaddressed Problems in theTax System

• Incidence (burden) of taxes on individual vs.
  corporations
• Do corps. pass on taxes to individuals through
  higher prices?
• If yes, then individuals bear the tax burden
• If no,then shareholders and employees bear the
  burden
• Distribution of wealth
• Increasing split between have and have-nots
• More wealth concentrated in fewer households

21
Unaddressed Problems in theTax System

• For taxpayers with higher incomes, tax laws are
  incredibly complex
• 29 of individuals itemize and all corporate
  taxpayers
• People expect more from government than they are
  willing to pay for
• High income taxpayers have heavy tax burden
• Individuals with highest 5 of income pay __ of
  individual income taxes

22
Unaddressed Problems in the Tax System

• Social Security and Medicare trust funds
  projected to run deficits.
• Until recently, Social Security receipts were
  used to pay for approximately 10 of government
  spending in other areas.
• Borrowing from Social Security Trust Fund is
  off-budget
• How to pay for Social Security and Medicare in
  the future.
• Social Security income tax is maxed out.
• Congress wants to cut taxes at top of economic
  cycle. What happens when the economy slows?