Economics – Sources of
Government Revenue
Chapter 9
Economic Impact of Taxes

Taxes affect factors of production and, therefore, resource
allocation. (pg. 211)

A tax placed on a good at a factory raises production costs (Supply
curves shifts left). If demand is unchanged, the equilibrium price
increases.

Taxes impact the economy by encouraging and/or discouraging
certain behavior.

A sin tax is a high-percentage tax that raises revenue while
discouraging consumption of a socially undesirable product (ex:
cigarettes)
Economic Impact
continued…

Taxes affect productivity and economic growth by
changing the incentives to invest, save, and/or work.

The incentive of a tax is the final burden of the tax: it is
easier for a producer to shift the incidence of a tax to the
consumer if the demand is inelastic; the more elastic the
demand, the more likely the producer will absorb a greater
portion of the tax.
?
Criteria for Effective Taxes

Taxes are effective when they are equitable, simple, and
efficient.
1.
2.
3.
Fairness and equity; fairness is is subjective, but taxes
are considered fairer if they have fewer loopholes –
exceptions, deductions, and exemptions.
Simplicity; easy to understand
Efficiency = easy to administer and successful at
generating revenue.
Two Principles of
Taxation
states that those that benefit from government
services and goods should pay in proportion to the a benefits they receive.

Limitations = many govt. services provide the greatest benefit to those who can
least afford to pay and the benefits are hard to measure.
is the belief that people should be taxed
according to their ability to pay, regardless of the benefits they receive.

Ability to pay principle is based on 2 ideas:
1.
Societies cannot always measure the benefits derived from govt. spending
2.
People with higher incomes suffer less discomfort in paying taxes than low income
people.
Types of Taxes
– imposes the same percentage on everyone,
regardless of income.
– imposes a higher percentage of tax on those
with higher incomes.
– imposes a higher percentage of tax on persons
with low incomes than on high income. (pg. 214)
Individual Income Tax

Fed. Govt. collects about 48% of its revenue from individual taxes.

Employers withhold taxes for individual paychecks and send to IRS.

Individuals file returns with IRS on or before April 15th. If taxes withheld
are more that taxes owed, the individual gets a refund; if not, the
individual makes a payment of the tax balance.

The individual income tax in the U.S. is progressive because those earning
higher incomes pay higher tax rates. (. Pg. 218 and 219)
FICA Taxes
(FICA)
tax pays for Social Security and Medicare.

FICA is the 2nd largest source of govt. revenue.

The FICA is a recessive tax, those with lower incomes pay a higher
proportion of their incomes.

Social Security is partly a proportional tax and partly a recessive tax.
Corporate Taxes

Corporations pay a tax on their profits because they
are considered legal entities.

Corporate tax is the 3rd largest source of government
revenue.
Other Federal Taxes

The excise tax is a regressive tax on the manufacture or sale of selected items.

The estate tax deals with the transfer of property when a person dies.

The gift tax is placed on large donations of money or wealth and is paid by
the donator.

A customs duty is a charge levied on goods brought in form other countries.

The Reagan administration implemented user fees for the use of goods and
services.

User fees are an example of taxation based on the benefits principle.
State Government
Revenue Sources

Intergovernmental revenues are funds collected by one level of government
that are distributed to another level.

Intergovernmental revenues are the largest source of revenues for state and
local governments – about ¼ of all state revenues.

A sales tax is one levied on consumer purchases for nearly all products.

Employee retirement contributions make up the 1/3 largest source of income.

Other sources of revenue include interest earnings on surplus funds; fees from
state-owned colleges, universities, and schools; corporate income taxes, and
hospital fees. (pg. 217, 223)
Local Government
Revenue Sources

Intergovernmental revenues are generally earmarked for education and public
welfare; they make up the largest source of government revenue.

Property taxes are levied on tangible and intangible products; they make up
the 2nd largest source

Local governments receive revenues from government-owned public utilities
and state-owned liquor stores.

Some towns and cities have a sales tax, which is collected along with the
state’s sales tax.

Other sources of local income include hospital fees, personal taxes, and public
lotteries. (map pg. 224)
Examining Your Paycheck

Looking at your payroll withholding statement will
help you identify many of your state and local
governments’ revenue sources. (pg. 225)

Additional deductions can be added to payroll for
retirement contributions, purchases savings bonds,
or credit unions.
Tax Reform

Under the Reagan administration, the Economic Recovery Act of 1981
reduced taxes for individuals and businesses.

Bt the mid-1980’s, Americans believe the tax code favored the rich and
powerful.

In 1986 Congressional tax reform limited the tax brackets to 15% & 28%

The Omnibus Budget Reconciliation Act of 1993 added 2 higher income
tax brackets (36 & 39.6%), but its goal was more to assist in balancing the
federal budget than in adjusting rates for income levels.

By 1997 the government had high tax revenues, so the Taxpayer Relief Act
was passed giving tax credits for children and educational expenses, and
reduced for people with capital gains from long-term investments in stock
and bonds.
Tax Reform Continued

By 2001, the government faced a surplus. President Bush backed tax
reduction, and the was a $1.35 billion, ten-year tax cut.

Some of the components of the 2001 tax bill were:




An immediate refund check
Higher child tax credits
Deductions for college educational expenses
The elimination of the estate tax
.
Valued-Added Tax

A value-added tax (VAT) places a tax on the value that manufacturers add
to a good at each stage of production.

Advantages to the VAT: the tax is levied on the total amount of sales less
the cost of inputs; the incidence of the tax is widely spread among the
manufacturers involved; it is easy to collect; it would encourage people to
save.

Disadvantages of the VAT: taxpayers are unlikely to notice increases in
VAT taxes; it would compete with state sales taxes; politicians would lose
some power in promoting pet projects. (pg. 229-230)
The Flat Tax

A flat tax is a proportional tax on individual income after a specified
income threshold has been reached.

Advantages of the flat tax: it would be simple to report; it would close
or minimize tax loopholes; it reduces the need for tax accountants and
much of the IRS; it could lead to savings of up to $100 billion.

Disadvantages of the flat tax: it removes the behavior incentive in the
tax code; it benefits those with high incomes; it shifts tax policy away
from the ability-to-pay principle.
The Inevitability of Future
Reforms

The complex tax code guarantees future attempts to simplify it.

Unexpected economic slowdowns could cause tax revenues to fall.

Unexpected political events may require unplanned expenditures, such as
Congress voting to spend $40 billion to rebuild New York City and the air
traffic system after September 11, 2001.

Tax reform is likely to continue because each political administration
abruptly changes policies to suit its agenda.

Politicians are reluctant to give up the power they have in adjusting the
current complex system.