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Chapter12TheDesignOfTheTaxSystemTheFederalGovernment•TheU.S.federalgovernmentcollectsabouttwo-thirdsofthetaxesinoureconomy.•Thelargestsourceofrevenueforthefederalgovernmentistheindividualincometax.TheFederalGovernment•IndividualIncomeTaxes•Themarginaltaxrateisthetaxrateappliedtoeachadditionaldollarofincome.•Higher-incomefamiliespayalargerpercentageoftheirincometaxes.TheFederalGovernment•TheFederalGovernmentandTaxes•PayrollTaxes:taxonthewagesthatafirmpaysitsworkers.•SocialInsuranceTaxes:taxesonwagesthatisearmarkedtopayforSocialSecurityand.•ExciseTaxes:taxesonspecificgoodslikegasoline,cigarettes,andalcoholicbeverages.TheFederalGovernment•FederalGovernmentSpending•Governmentspendingincludestransferpaymentsandthepurchaseofpublicgoodsandservices.•Transferpaymentsaregovernmentpaymentsnotmadeinexchangeforagoodoraservice.•Transferpaymentsarethelargestofthegovernment’sexpenditures.TheFederalGovernment•FederalGovernmentSpending•ExpenseCategory.•SocialSecurity•NationalDefense•IncomeSecurity•Netinterest•Medicare•Health•OtherTheFederalGovernment•BudgetSurplus•Abudgetsurplusisanexcessofgovernmentreceiptsovergovernmentspending•BudgetDeficit•AbudgetdeficitisanexcessofgovernmentspendingovergovernmentspendingTheFederalGovernment•FinancialConditionsoftheFederalBudget•Abudgetdeficitoccurswhenthereisanexcessofgovernmentspendingovergovernmentreceipts.•Governmentfinancesthedeficityborrowingfromthepublic.•Abudgetsurplusoccurswhengovernmentreceiptsaregreaterthangovernmentspending.•Abudgetsurplusmaybeusedtoreducethegovernment’soutstandingdebts.StateandLocalGovernments•Stateandlocalgovernmentscollectabout40percentoftaxespaid.•Receipts•SalesTaxes•PropertyTaxes•IndividualIncomeTaxes•CorporateIncomeTaxes•FederalGovernment•OtherStateandLocalGovernments•Spending•Education•PublicWelfare•Highways•OtherStateandLocalGovernments•Policymakershavetwoobjectiveindesigningataxsystem…•Efficiency•EquityTaxesandEfficiency•Onetaxsystemismoreefficientthananotherifitraisesthesameamountofrevenueatasmallercosttotaxpayers.•Anefficienttaxsystemisonethatimposessmalldeadweightlossesandsmalladministrativeburdens.TaxesandEfficiency•TheCostofTaxestoTaxpayers•Thetaxpaymentitself•Deadweightlosses•AdministrativeburdensTaxesandEfficiency•Becausetaxesdistortincentives,theyentaildeadweightlosses.•Thedeadweightlossofataxisthereductionoftheeconomicwell-beingoftaxpayersinexcessoftheamountofrevenueraisedbythegovernment.DeadweightLosses•Complyingwithtaxlawscreatesadditionaldeadweightlosses.•Taxpayersloseadditionaltimeandmoneydocumenting,computing,andavoidingtaxesoverandabovetheactualtaxestheypay.•Theadministrativeburdenofanytaxsystemispartoftheinefficiencyitcreates.AdministrativeBurdens•Theaveragetaxrateistotaltaxespaiddividedbytotalincome.•Themarginaltaxistheextrataxespaidonanadditionaldollarofincome.MarginalTaxRatesversusAverageTaxRates•Alump-sumtaxisataxthatisthesameamountforeveryperson,regardlessofearningsoranyactionsthatthepersonmighttake.Lump-SumTaxes•Howshouldtheburdenoftaxesbedividedamongthepopulation?•Howdoweevaluatewhetherataxsystemisfair?TaxesandEquity•PrinciplesofTaxation•Benefitsprinciple•Ability-to-payprincipleTaxesandEquity•Thebenefitsprincipleistheideathatpeopleshouldpaytaxesbasedonthebenefitstheyreceivefromgovernmentservices.•Anexampleisagasolinetax:•Taxrevenuefromagasolinetaxareusedtofinanceourhighwaysystem.•Peoplewhodrivethemostalsopaythemosttowardmaintainingroads.BenefitsPrincipleAbility-to-PayPrinciple•Theability-to-payprincipleistheideathattaxesshouldleviedonapersonaccordingtohowwellthatpersoncanshouldertheburden.•Theability-to-payprincipleleadstotwocorollarynotionsofequity.•Verticalequity•HorizontalequityAbility-to-PayPrinciple•Verticalequityistheideathattaxpayerswithagreaterabilitytopaytaxesshouldpaylargeramounts.•Forexample,peoplewithhigherincomesshouldpaymorethanpeoplewithlowerincomes.Ability-to-PayPrinciple•VerticalEquityandAlternativeTaxSystem•Aproportionaltaxisoneforwhichhigh-incomeandlow-incometaxpayerspaythesamefractionofincome.•Aregressivetaxisoneforwhichhigh-incomepayasmallerfractionoftheirincomethandolow-incometaxpayers.•Aprogressivetaxisoneforwhichhigh-incomepayalargerfractionoftheirincomethandolow-incometaxpayers.Ability-to-PayPrinciple•HorizontalEquity•Horizontalequityistheideathattaxpayerswithsimilarabilitiestopaytaxesshouldpaythesameamounts.•Forexample,twofamilieswiththesamenumberofdependentsandthesameincomelivingindifferentpartsofthecountryshouldpaythesamefederaltaxes.CaseStudy:HorizontalEquityandtheMarriageTax•Marriageaffectsthetaxliabilityofacoupleinthattaxlawtreatsamarriedcoupleasasingletaxpayer.•Whenacouplegetsmarried,theystoppayingtaxesasindividualsandstartpayingtaxesasafamily.•Ifeachhasasimilarincome,theirtotaltaxliabilityriseswhentheygetmarried.TaxIncidenceandTaxEquity•Thedifficultyinformulatingtaxpolicyisbalancingtheoftenconflictinggoalsofefficiencyandequity.•Thestudyofwhobearstheburdenoftaxesiscentraltoevaluatingtaxequity.•Thisstudyiscalledtaxincidence.TaxIncidenceandTaxEquity•Thedifficultyinformulatingtaxpolicyisbalancingthe