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Government Revenue

Government Revenue. Citizens of the United States authorize the government, through the Constitution and elected officials, to raise money through taxes. Taxation is the primary way that the government collects money.

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Government Revenue

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  1. Government Revenue • Citizens of the United States authorize the government, through the Constitution and elected officials, to raise money through taxes. • Taxation is the primary way that the government collects money. • 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

  2. 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. The Constitution and Taxation

  3. 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

  4. 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.

  5. Elasticities of Demand and Tax Effects Inelastic Demand Elastic Demand New supply with $.50 tax New supply with $.50 tax f $1.40 Original supply Original supply Price Price g $1.10 i i $1.00 $1.00 Demand Demand Lower quantity Higher quantity Lower quantity Higher quantity Quantity Quantity • 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.

  6. 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.

  7. 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.

  8. HOURS AND EARNINGS TAXES AND DEDUCTIONS Hours Earnings Description Amount 20 200.00 FICA Federal State City Total Taxes 15.20 10.25 5.10 1.00 31.55 TOTAL Taxable Wages Less Taxes Net Pay 200.00 31.55 168.45 • 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. • Deductions are variable amounts that you can subtract from your gross income.

  9. 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

  10. 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 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. 2 Principles of Taxation

  11. 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 tax-sheltered income still pay their fair share.

  12. Tax Brackets: 2007, Singles • 10%: from $0 to $7,825 • 15%: from $7,851 to $31,850 • 25%: from $31,850 to $77,100 • 28%: from $77,101 to $160,850 • 33%: from $160,851 to $349,700 • 35%: $349,700 and above • http://www.irs.gov/pub/irs-drop/rp-06-53.pdf

  13. Tax Terminology • 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 • 1040PC: Computer software tax form • Form 4868/2688: Extensions (must pay interest)

  14. Calculating Personal Income Tax • Hypothetical Scenario: • Male, age 27. Single. • Makes $52,000/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%?

  15. How Much Tax Does the Poor Teacher Owe? Tax brackets on AGI: 10%: 0 to $7,550 15%: $7,551 to $30,650 25%: $30,651 to $74,200 28%: $74,201 to $154,800 33%: $154,801 to $336,550 35%: $336,551 and above • Take total tips and wages: $52,000 • Interest income: 100 • Total Income: $52,100 • Subtract personal exem. - 3000 • Tax credit (st. loan) - 3000 (itemized) • Charitable Contributions - 2000 (itemized) • Tax credit: mortgage int. - 4000 (itemized) • AGI= $40,100 • Tax owed= (.10*7550)+ (.15*23100)+ (.25*9450)=$6582.50 • 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: ($6582.50/$52100)=12.6% • Flat tax result would depend on plan’s exemption level. • 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 without itemizing. If you have large charitable contributions, ITEMIZE! • (Itemized Deductions= $9000. Standard is only $5000)

  16. What about the 2001 Bush tax cut? • Teacher w/o tax cut would have paid: (.15*30650)+ (.28*15050)=$7243.50 • Teacher saves $661. 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%

  17. But we’re not done More tax to pay! • So, some of the poor teacher’s money is taxed at 25% • Michigan State Income Tax= 3.9% flat rate in 2006 • Social Security Tax= 7.65% until $70K (6.2% +1.45% Medicaid) • City tax (in some localities, but not mine!) • Total tax % on SOME of the money earned= 38.7%! • But then there’s sales tax, 6%, so if you spend some of that $400, the tax rate shoots to 41.5% • Add in state and local property tax • As you can see, we are taxed to death in this society. • THERE ARE EVEN MORE TYPES OF TAXES—PATIENCE MY FRIENDS

  18. Incentives Matter(Or why our tax code hurts those who follow the rules) • Let’s suppose our poor teacher was terribly irresponsible and had 4 kids out of wedlock. • Total Tax Owed? • $52,100- (5000+ 2950*5)=$32,350 AGI • Tax= ($7550*.10)+(23100*.15)+ (.28*1700) =$4696.50 • Tax saved by fathering out of wedlock: $1886 • Of course, this would apply to widowers too, but either father could claim child care credits and pay even less. Father benefits more from services too—schools, etc.

  19. Corporation Income Tax • 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

  20. 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 Old-Age, Survivors, and Disability Insurance (OASDI) Medicare Taxes-Medicareis 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

  21. Other Taxes • 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.

  22. 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)

  23. The Supply-Side Theory of Taxation • 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)

  24. The Laffer Curve

  25. 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. • National Sales Tax (Consumption tax)

  26. 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

  27. 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!

  28. State Government Revenue Sources • 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 state-owned colleges, corporate income taxes, fees from licensing • Public lotteries are another source of funding (In Michigan, all lottery money goes to public education)

  29. 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.

  30. Property taxes are the main source of local revenue. These taxes are paid by people who own homes, apartments, buildings, or land. Michigan: Proposal A (1994) eliminated the funding of schools with property taxes Local governments sometimes collect excise, sales, and income taxes. Some taxes, such as room and occupancy taxes, are aimed at nonresidents in order for local governments to earn additional revenue. Local Government Revenue

  31. What do these Monstrous Taxes Pay For? • National defense • Welfare programs • Public education (Federal prerogative?) • Interest on the national debt • Pork barrel spending

  32. Ok, but where do state taxes go? • 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.

  33. 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.)

  34. 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.

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