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Chapter 25

Joseph A. Brittian Presents. Chapter 25. Fundamental Tax Reform. Chapter Outline. Problems with the current tax code Tax evasion and compliance Tax efficiency Past reforms and political pressures Tax shelters and transitional inequities Consumption taxes

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Chapter 25

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  1. Joseph A. Brittian Presents Chapter 25 Fundamental Tax Reform

  2. Chapter Outline • Problems with the current tax code • Tax evasion and compliance • Tax efficiency • Past reforms and political pressures • Tax shelters and transitional inequities • Consumption taxes • VAT, national retail sales tax, expenditure tax, cash-flow tax, flat tax

  3. Why Reform the Tax Code? • Difficulties and costs of enforcement • Compliance • Large numbers of tax expenditures • Tax expenditures => deductions, exemptions, and exclusions • High marginal tax rates

  4. Tax Evasion in Action: Pg. 740

  5. Is Compliance Important? • “tax gap” => $345 billion (U.S.) • Efficiency losses • Vertical Equity • Horizontal Equity

  6. Tax Efficiency • Direct effect of tax changes • Indirect effects of tax changes: • Gross Income Effect: higher tax rate may reduce gross income generated by lowering the amount of labor supplied, savings undertaken, or risk taking • Reporting Effect: higher tax rate will cause individuals to reclassify income • Income Exclusion Effect: higher tax rate causes more to use deductions, exemptions, exclusions • Compliance Effect: higher tax rates may increase tax evasion

  7. Past Tax Reform • Tax Reform Act of 1986 • 1993 Tax Reform • 2001 and 2003 Tax Reform

  8. Political Pressures • Financing by tax expenditure • Result: a complicated tax code

  9. Tax Shelters • Examples: • Real estate tax breaks • $2 of write-offs for every $1 invested • Deduction for oil and gas drilling • 60-80% of initial investment deducted • Tax credit for equipment leasing for scientific research • 10% of equipment cost

  10. Transitional Inequities • Tax capitalization • Transitional inequalities from tax reform • Horizontal inequity

  11. Consumption Taxes • Consumption => Income – savings • Taxing consumption • Improved Efficiency • Less biased towards those who save • Simplicity

  12. Consumption Taxes: OECD

  13. Consumption Taxes: Why not? • Vertical equity • Consumption of the rich vs. poor • Asymmetric information • Transition issues • Generational differences • Older generations => Double Taxation • Compliance • Cascading

  14. Value-added Tax (VAT) • Taxing Businesses • Rebates • Advantages • Compliance, cascading, and investment • Disadvantages • Possibly complicated exemptions • Cost of enforcement can be high • Compliance problems can exceed U.S. income tax

  15. VAT

  16. National Retail Sales Tax • Advantages • “perceived” simplicity • Disadvantages • Retailers purchase items for personal use • Consumers do not keep detailed records • Enforcement can be difficult and costly • Cascading • State objections: competition

  17. Expenditure Tax • Reaction to progressivity demand • Tax levied on yearly consumption • Tax base = consumption • Compliance • Difficulty for individuals to keep receipts • Very difficult to enforce

  18. Cash-flow Tax • Taxes individuals on the difference between cash income and savings • Advantages • Requires little change to current system • Only major difficulty is verifying people’s claimed yearly savings. • High-income taxpayers who save in other forms • Benefitting the rich?

  19. Flat Tax • Constant tax rate • Imposed upon individuals, corporations or both • Efficiency gains: removing tax expenditures and allowing marginal tax rates to stay low • Compliance likely to improve • Transition issues and vertical equity

  20. Simplicity

  21. The Rabushka-Hall Proposal • Abolition of current corporate and personal income taxes • Flat 19% VAT on businesses, not taxing workers’ wages, salaries, & pensions • 19% individual flat tax on income, not capital income • Elimination of all tax expenditures • Single family-level exemption

  22. Modifications to Proposal • Alter single family-level exemption: Rabushka and Hall use 1981 statistics; this exemption level should be adjusted annually to account for rising costs in living • Temporary relief program due to removal of certain tax expenditures, with set time schedules

  23. Questions/Concerns • Fundamental Tax Reform • Modified Rabushka and Hall proposal

  24. References Gruber, Jonathan (2011). Public Finance and Public Policy. New York: Worth Publishers.

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