More on taxationTodayRecall from last lectureEfficient taxation/tax dodgingEfficient taxationThe Ramsey ruleEquity concernsShould we look at fairness, too?Tax evasion/tax avoidanceExamples of tax avoidanceTax evasion theorySummary: Efficient taxation/tax dodgingThe US Personal Income TaxDigesting federal income tax liabilityHow should income be defined?Is all Haig-Simons income taxed?Other features of the US tax systemMore on simplicitySlide 19Marginal tax ratesSlide 21Inflation issuesSummary: The US Personal Income TaxMore on taxationToday: More on efficiency and equitability; An introduction to the US personal income taxTodayMore on taxationWhat should be taxed in order to gain efficiency?Tax evasion versus tax avoidanceUnderground economiesAn introduction to the US personal income taxDefining incomeMoney valueIncome used for tax purposesComputation of tax liabilityExemptions, deductions, credits, marginal tax rates, inflation, the alternative minimum taxRecall from last lectureTaxes will sometimes change behavior so much that total taxes collected may actually go downExample: Yacht tax in the early 1990sTax on yachts over $100,000 purchased in the USPeople bought yachts in other countriesNet economic impact$16.6 million in taxes collected (less than the $31 million predicted)Less income tax paid by workers (7,600 jobs lost in the US)Efficient taxation/tax dodgingAlthough the yacht tax was likely implemented to be “equitable,” efficiency suffered on all marginsExcess burden due to the taxDecreased overall tax revenue collected due to jobs lost in the USWhat kinds of taxes lead to less excess burden?Efficient taxationAssume that the amount of tax revenue collected is set at a constant levelShould everything be taxed at the same rate in order to make the most efficient outcome?Taxing each good at the same rate is known as neutral taxationSee Figure 16.1, p. 355Marginal excess burdenThe Ramsey ruleHow do we tax to reduce excess burden?Ramsey rulePercentage reduction in quantity demanded for every good is the sameBack to our old question: Should everything be taxed at the same rate in order to make the most efficient outcome? NOOne other concept to keep in mindMarginal excess burden generally increases as the tax increasesEquity concernsFrom the Ramsey rule, inelastic goods should be taxed at higher rates in order to gain efficiencyCoffeeTheater/operaSaltMany prescription drugsExample: Insulin needed to liveShould we look at fairness, too?Many people believe that fairness is just as important as efficiencyThis type of person would… Probably not want to tax insulinImpose a higher tax on goods that high-income consume moreNot want to impose a lump sum taxTax evasion/tax avoidanceTax evasionNot paying taxes that are legally owed to a governmentTax avoidanceAltering behavior to legally pay less in taxesExamples of tax avoidanceRecall yacht tax in the early 1990sTax on yachts over $100,000 purchased in the USTax avoidance: People bought yachts in other countriesNet economic impact in the US was negative18th century tax in BrazilTax on finished churchesTax avoidance: Build churches that were complete except for some trivial part that was not builtSee bottom picture on p. 371This church is not “finished” since it is missing one of its towersTax evasion theoryMarginal benefit of cheating on taxes is constant$1 for each dollar in taxes avoidedMarginal cost is increasingProbability of getting caught cheating increases as the number of “red flags” increasesIf MB > MC for some people (for the first dollar in tax evasion), an underground economy developsSee Figures 16.5 and 16.6, p. 373 and 374, respectivelyFigure 16.5: Tax evasion is positiveFigure 16.6: Tax evasion is zeroSummary: Efficient taxation/tax dodgingEfficient taxation comes from the Ramsey rulePercentage reduction in quantity demanded for every good is the sameEquity concerns are important in many people’s mindsTax evasion and tax avoidance are used to lower the amount of taxes a person paysNote that tax evasion is illegalThe US Personal Income TaxAbout 45% of federal revenues are generated through personal income taxesFederal taxes are easy and simple to understand, right?See Figure 17.1, p. 381 for the answerDigesting federal income tax liability Tax Base- “Above-the-line” deductions Adjusted Gross Income- Exemptions- Larger of standard deduction or itemized deductions Taxable Income• tax rate Tax liability before credits- Tax credits Regular tax liability Wages and compensation, interest, dividends, capital gain (or loss), business income (or loss), pensions, farm income (or loss), rents, royalties, Social Security benefits, etc.Trade or business expenses, moving expenses, educator expenses, self-employed health insurance premium payments, student loan payments, tuition and fees, alimony paid, etc.Phase-out with incomeCharitable contributions, home mortgage interest, state and local taxes, medical expenses in excess of 7.5% of AGI, casualty and theft losses, non-reimbursed employee expenses; Phase out with income; Differs by filing statusSix ordinary rates (10%, 15%, 25%, 28%, 33%, 35%); differs by filing status; special rates for dividends and capital gainsChild tax, additional child tax, EITC, HOPE and Lifetime Learning, electric vehicles, health coverage tax, adoption, mortgage interest, retirement savings contribution, child and dependent care credit, credit for the elderly or the disabled, D.C. First-Time homebuyer’s credit, etc.; Phase-out with income Start over to determine AMT tax liability using AMT base. Pay tentative AMT liability in excess of regular tax liabilityPay tax or claim refundHow should income be defined?Haig-Simons definition of income“Money value of the net increase in an individual’s power to consume during a period” (R/G p. 382)Besides traditional income, what should be counted according to this definition?Pension contributions, insurance purchases, and in-kind benefits given by an employerAny monetary or in-kind transfer from the governmentCapital gainsIs all Haig-Simons income taxed?NoInterest on state and local bondsLegal issues?Makes these bonds more attractiveUnrealized capital gainsLeads to
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