Government Revenue

Citizens of the United States authorize the government,
through the Constitution and elected officials, to raise
money through taxes.
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Taxation is the primary way that the government
collects money.
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Without revenue, or income from taxes, government
would not be able to provide goods and services.

Taxes affect resource allocation and
encourage/discourage certain activities
The Constitution and Taxation
The Power to Tax
 Article 1, Section 8,
Clause 1 of the
Constitution grants
Congress the power to
tax.
 The Sixteenth
Amendment gives
Congress the power to
levy an income tax.
Limits on the Power to Tax
 The power to tax is also
limited through the
Constitution. According
to the Constitution:
1. The purpose of the tax
must be for “the common
defense and general
welfare.”
2. Federal taxes must be
the same in every state.
3. The government may
not tax exports.
Tax Structures
Proportional Taxes
– A proportional tax is a tax for which the
percentage of income paid in taxes remains the
same for all income levels. EX: “Flat Tax” proposal
Progressive Taxes
– A progressive tax is a tax for which the percent of
income paid in taxes increases as income increases.
EX: Federal Income Tax
Regressive Taxes
– A regressive tax is a tax for which the percentage
of income paid in taxes decreases as income
increases. EX: National Sales Tax proposal, Social
Security Taxes
What Makes a Good Tax?
(As of there is such a thing)

Simplicity--Tax laws should be simple and easily
understood. (Look at a 1040—ha!)
 Certainty--It should be clear to the taxpayer when the
tax is due, how much is due, and how it should be
paid. (Value-Added Tax bad for this)
 Economy--Government administrators should be able
to collect taxes without spending too much time or
money.
 Equity--The tax system should be fair, so that no one
bears too much or too little of the tax burden. No
loopholes.
To fully evaluate the fairness of a tax, it is important to
think about who bears the incidence of a tax , or the final
burden. If demand is inelastic, a tax will increase the
price of a good and consumers will bear a large burden of
the tax. If demand is elastic, the opposite is true.
Elasticities of Demand and Tax Effects
Inelastic Demand
Elastic Demand
New supply
with $.50 tax
New supply
with $.50 tax
Price
Original
supply
i
$1.00
Price
f
$1.40
Original
supply
g
$1.10
$1.00
i
Demand
Demand
Lower
quantity
Quantity
Higher
quantity
Lower
quantity
Quantity
Higher
quantity
Section 1 Review
1. The power to tax is granted by the United States
Constitution to
(a) the Treasury Department.
(b) Congress.
(c) the President.
(d) the Supreme Court.
2. All of the following are characteristics of a good tax
except
(a) economy.
(b) certainty.
(c) revenue.
(d) equity.
Individual Income Taxes
“Pay-as-You-Earn” Taxation
– Federal income taxes are collected throughout the
course of the year as individuals earn income.
Tax Withholding
– Withholding is the process by which employers take
tax payments out of an employee’s pay before he or
she receives it.
Tax Brackets
– The federal income tax is a progressive tax. In 2002,
there are 6 rates, each of which applied to a different
range of income. See handout.
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A tax return is a form on which you declare your
income to the government and determine your
taxable income.
Taxable income is a person’s total (or gross) income
minus exemptions and deductions.
Exemptions
are set
amounts that
you subtract
from your
gross income
for yourself,
your spouse,
and any
dependents.

HOURS AND EARNINGS
Hours
Earnings
20
200.00
TAXES AND DEDUCTIONS
Description
Amount
FICA
15.20
Federal
10.25
State
5.10
City
1.00
Total Taxes
31.55
TOTAL
Taxable Wages
Less Taxes
Net Pay
200.00
31.55
168.45
Deductions
are
variable
amounts
that you
can
subtract
from your
gross
income.
In the Beginning…
Taxes originally were only applied
against the extremely wealthy
 The New Deal and World War II
changed that, maybe forever
 94% Tax rate during WW2 for the
highest income earners

2 Principles of Taxation
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Benefit Principle
Those who benefit the
most form taxes should
pay in proportion to the
benefits they receive
EX: Turnpike tolls
Limitations: Benefits hard
to measure, and those
who get the most can
hardly pay for them.
EX: Large family gets
huge benefits from public
schools, low cost
subsidized health care
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Ability-to-Pay Principle
People should be taxed
according to their ability
to pay, regardless of
benefits they receive
Argument: It’s the
system that allows you to
be wealthy.
Limitations: Fairness,
destroys incentive,
punishes people for doing
well.
Top 25% of all income
earners pay 83% of FIT
Individual Income Taxes
The government gets 48% of its revenue from the
individual income tax (more than any other method)
 Taxes are typically withheld, but individuals must file a
tax return on or before April 15th of every year. 1099s
must be send out by the end of January.
 The tax is progressive in structure, but can be
regressive in reality because of loopholes that allow
wealthier citizens to deduct more expenses.
 Some loopholes have been closed—Alternative
Minimum Tax makes sure people with lots of taxsheltered income still pay their fair share.

Adjusted Gross Income
Tax Brackets: 2008
SINGLES:
 MARRIED FILING JOINTLY:
 10%:$0 to $8,025
 10%: 0-$16,050
 15%:$8,026 to $32,550  15%: $16,051-$65,100
 25%: $32,551 to
 25%: $65,101-131,450
$78,850
 28%: $131,451-$200,300
 28%: $78,851 to
 33%: $200,301-$357,700
$164,550
 35%: $357,701 +
 33%: $164,551 $357,700
 Note “Marriage Penalty”
 35%: $357,701 +
 Rates jump to 39.6% in 2011
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Tax Terminology
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W-2: Shows the amount of tax your employer
withheld
W-4: Filled out when you are hired determines
withholding rate
1099: Shows interest income on investments.
Different types. Dividends (DIV), Retirement (R ),
Tuition (G),
1040EZ: short form tax return, must have no
dependents other than spouse, and must earn less
than $50,000 with than $400 interest income
1040A: Can subtract IRA deductions, take child care
credits, less than $50,000 income
1040: Main form
Calculating Personal Income Tax
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Hypothetical Scenario:
Male, age 29.
Makes $60,000/year teaching little brats
$100 interest income from bank CD
No stock sales
Deductions for home mortgage—must itemize ($4000)
Has student loan interest to deduct, $2000
Charitable Contributions, $2000
Calculate this person’s tax and how much the Bush tax cut of
2001 saved him
Would this teacher benefit from a Forbes-style “flat tax” of
17%?
How Much Tax Does the Poor Teacher Owe?
(Single Teacher) Tax brackets: Singles
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10%:$0 to $8,025
Take total tips and wages: $60,000
15%:$8,026 to $32,550
Interest income:
100
25%: $32,551 to $78,850
Total Income:
$60,100
28%: $78,851 to $164,550
Subtract pers. exemption
-3500
33%: $164,551 - $357,700
Student loan interest
-2000
35%: $357,701 +
$5450 std deduction or ITEMIZE if more than $5450
Charitable Contributions
-2000
Home mortgage interest
-4000
State Income/Sales/Property tax deduction -4000
Total Itemized Deductions -10,000
AGI= $44600
Tax owed= (.10*8025)+ (.15*24525)+ (.25*12050)=
802.50+3678.75+3012.50= $7493.75
Ouch! Highest Marginal tax rate is 25 %. Would this
teacher be willing to teach college evening classes?
Probably NOT. Extra income gets taxed at 25%, not 15%-Incentive is removed.
Overall tax rate: ($7493.75/$60100)=12.5%
Note that charitable contributions, student loan interest
and mortgage interest are not 100% tax-deductible.
Personal exemption can be higher if ITEMIZED--student
loan interest/mortgage is usually deductible on 1040A
What about the 2001/03 Bush tax cuts?
Teacher w/o tax cut would have paid: (.15*32550)+
(.28*12050)=$8256.50
 Teacher saves $762.75. Not bad.
 Dick Cheney saved $380,000 in 2002.
 BUT
 Dick Cheney also paid over $14 Million in tax at a top
marginal rate of 38.6%
 Flat tax result would depend on plan’s exemption
level.

Married Teacher Scenario—
or “Why I Love My L’il Tax Deduction”
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Tax brackets: Married Jointly
10%: 0-$16,050
15%: $16,051-$65,100
25%: $65,101-131,450
28%: $131,451-$200,300
33%: $200,301-$357,700
35%: $357,701 +
Take total tips and wages: $60,000
Interest income:
100
Total Income:
$60,100
Subtract pers. exemptions - 7000
Student loan interest
- 2000
No longer makes sense to itemize -10,900 std. deduction
AGI= $40,200
Tax owed= (.10*16050)+ (.15*24150)=$5227.50
:
Highest Marginal tax rate DROPS to 15 %.
Married teacher with no spouse income saves $2226.25
Overall tax rate: ($5227.50/$60100)=8.69%
Mott CC here I come!
But we’re not done 
More taxes to pay!
Some of the poor single teacher’s money is taxed at 25%
Michigan State Income Tax= 4.35% flat rate in 2008
Social Security Tax= 7.65% until $70K (6.2% FICA +1.45%
Medicaid)
 City tax (in some localities, but not mine…Detroit is 2%)
 But then there’s sales tax, 6%, so if you spend some of that
$400, the tax rate shoots to 43%
 Add in property taxes—about $2000 a year..3%
 Do you smoke? Pay more tax.
 Total taxes can be more than HALF of your income
 As you can see, we are taxed to death in this society.
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Incentives Matter
(Or why our tax code hurts
those who follow the rules)
Let’s suppose our single teacher had 4 kids and was a widower
 Total Tax Owed?
 $60,100- (5450+ 3500*5)=$37150 AGI
 Tax= ($8025*.10)+(24525*.15)+ (.28*4600) =$5769.25
 4 kids * $1000 child tax credit= $4000
 Final tax bill= $1769.25
 Tax saved by having 4 kids: $5724.50
 Widowers could claim child care credits and pay even less.
 Father benefits more from services too—schools, etc.
 Obviously, this can be a sensitive topic and money is not the
only issue here—but it is nonetheless significant.
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Corporation Income Tax
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Like an individual, a corporation must pay a federal
tax on its taxable income.
Corporate income taxes are progressive – as a
company’s profits increase so does the amount paid
in taxes.
3rd largest source of government revenue
Add in state corporate taxes and we have some of
the highest in the world—terrible for business and
jobs here
2008 rates: 35% federal, w/state tax average is
39.3%
What the heck is this FICA?
(2nd largest source of Gov’t revenue)
Social Security Taxes-This program is funded by the
Federal Insurance Contributions Act (FICA). Most of
the FICA taxes you pay go to Social Security, or OldAge, Survivors, and Disability Insurance (OASDI)
Medicare Taxes-Medicare is a national health insurance
program that helps pay for health care for people over
65 and for people with certain disabilities. Medicare is
also funded by FICA taxes.
Unemployment Taxes-Unemployment taxes are collected
by both federal and state governments. Workers can
collect “unemployment compensation” if they are laid
off through no fault of their own and if they are actively
looking for work.
 Side note: Totalization agreements with the SSA exist
Other Taxes
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Excise Taxes-- a tax on the sale or production of a good.
Federal excise taxes range from gasoline to telephone
services. Alcohol and cigarettes are subject to excise
taxes, frequently called “sin taxes.” You can also
include “gas guzzler” tax on a Viper and Luxury tax on
yachts, etc (Thank goodness that one’s gone. Why?)
Estate Taxes--a tax on the estate, or total value of the
money and property, of a person who has died. Estate
taxes are paid before inheritors receive their share.
Gift Taxes--tax on the money/property that a person
gives to another. $10,000/person per year is exempted
Tariffs--Taxes on imported goods. Usually protective.
EX: Bush slapped 30% tax on imported steel to help
American steelworkers. Result? Prices go up 30%.
Customs Duties—levy on goods from another country
Capital Gains--Investments taxed at different rate from
income. Even home sales count as capital gains.
Recent Tax History
Economic Recovery Act of 1981 reduced taxes, 1986 act cut top
rate to 28%.
 President Bush (41) went along with a Democrat-controlled
Congress and raised taxes to 31%.
 Omnibus Budget Reconciliation Act of 1993 added 2 higher tax
brackets, 36% and 39.6%
 1997: Taxpayer Relief Act passed by Congressional
Republicans. Additional tax credits for children and educational
expenses and reduced long term capital gains taxes
(25%20%). No income rate reductions.
 2001--Top rate cut to 35%;
 2003- Tax on dividends and capital gains slashed to 15% (5%
if you’re in the lower two brackets)
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The Supply-Side Theory of Taxation
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Supply-Side Economics (a.k.a. “Trickle down theory”)
If you cut taxes on the wealthy, they will spend and
invest their additional discretionary income.
This spending picks up business, and businesses must
hire new workers.
Now that these new workers have a paycheck, they
spend and their purchases put businesses in a position
to higher even more workers.The cycle continues
indefinitely.
Revenues actually increase; people are wealthier and
pay more taxes, even though the % taxed is LESS!!!
Proof: Revenues doubled in 1980s after 2 Reagan cuts
Key believers: Andrew Mellon, Ronald Reagan
Why does this make sense? Laffer Curve (see next
slide)
The Laffer Curve
Proposals for Reform
Value-Added Tax: Places a tax on
manufactured goods at each level of
production. Simple, but potentially misleading
to consumers. Used extensively in Europe.
 Flat Tax: Exceedingly simple, would save time
and money in collecting. It is progressive as
long as there is some level of exempted
income. Seen as a giveaway to the very rich,
but consider trickle-down.
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Taxation Section Review
1. Taking taxes out of an employee’s wages before he or she
receives them is called
(a) tax return.
(b) social security.
(c) FICA.
(d) withholding
2. How is the federal income tax a progressive tax?
(a) The higher the income a person has, the higher the
percentage that person pays as tax.
(b) A person with a higher income pays more money in
taxes, although the percentage he or she pays as tax is
less.
(c) Two married people who file their taxes together will
pay more taxes than a single person will.
(d) Children pay no taxes, regardless of whether they earn a
large income
State Budgets
Operating Budgets
– A state’s operating budget pays for day-to-day
expenses. These include salaries, supplies, and
maintenance of state facilities.
Capital Budgets
– A state’s capital budget pays for major capital, or
investment, spending.
Balanced budgets
– Some states have laws requiring balanced
budgets. These laws, however, only apply to a
state’s operating budget.
Budgets mean TAXATION IS PRESENT!
State Government Revenue Sources
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Intergovernmental revenues are funds collected by
one level of government and distributed to another.
They make up ¼ of all state revenues and are the
largest source.
Most states have sales taxes—2nd largest source.
Employee retirement contributions are the 3rd largest
source of income
Individual income taxes—4th largest (depends on
state)
Other sources: Interest on surpluses, fees from stateowned colleges, corporate income taxes, fees from
State and Local Taxation
Limits to State Taxation
– Because trade and commerce are considered national
enterprises, states cannot tax imports or exports.
They also cannot tax goods sent between states.
Sales Taxes
– Sales taxes are the main source of revenue for many
states
Other State Taxes
– Different states have various other means to collect
revenue, such as state income taxes, excise taxes,
corporate income taxes, business taxes, and property
taxes.
Local Government Revenue

Property taxes are the main source of local revenue.
These taxes are paid by people who own homes,
apartments, buildings, or land.
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Michigan: Proposal A (1994) eliminated the funding
of schools with property taxes
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Local governments sometimes collect excise, sales,
and income taxes.
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Some taxes, such as room and occupancy taxes, are
aimed at nonresidents in order for local governments
to earn additional revenue.
What do these Monstrous
Taxes Pay For?
National defense
 Welfare programs
 Public education (Federal prerogative?)
 Interest on the national debt
 Pork barrel spending
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Ok, but where do state taxes go?
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Education--State education budgets help finance public
state universities and provide some aid to local
governments for elementary, middle, and high schools.
Public Safety--State governments operate state police
systems, as well as correctional facilities within a state.
Highways and Transportation--Building and
maintaining highways is another state expense. States
also pay some of the costs of waterways and airports.
Public Welfare--State funds support some public
hospitals and clinics. States also help pay for and
administer federal benefits programs.
Arts and Recreation--State parks and some museums
and historical sites are funded by state revenues.
Administration--Like the federal government, state
governments spend money just to keep running.
The Jobs of Local Government
Public school systems
Law enforcement
Fire protection
Public transportation
Public facilities, such as libraries and
hospitals
Parks and recreational facilities
Record keeping (birth/death certificates,
wills, etc.)
Section Review
1. For most state governments, the main source of
revenue is a
(a) room tax.
(b) property tax.
(c) general excise tax.
(d) statewide sales tax.
2. The main source of revenue for local governments is
(a) a property tax.
(b) an excise tax.
(c) a sales tax.
(d) an income tax.