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The Economic “Big Picture” Part 1: Income and Taxes

The Economic “Big Picture” Part 1: Income and Taxes. Dr. Katie Sauer Metropolitan State College of Denver ( ksauer5@mscd.edu ). Colorado Council for Economic Education 4/28/2012. pay back debt. economy. taxes. income. spending. borrowing. insurance.

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The Economic “Big Picture” Part 1: Income and Taxes

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  1. The Economic “Big Picture” Part 1: Income and Taxes Dr. Katie Sauer Metropolitan State Collegeof Denver (ksauer5@mscd.edu) Colorado Council for Economic Education 4/28/2012

  2. pay back debt economy taxes income spending borrowing insurance saving & investing human capital human capital

  3. Session Overview I. Intro to Income II. Two Main Determinants of Income - human capital - state of the economy III. A Simple Model of the Labor Market IV. Taxes Individuals Pay

  4. I. Intro to Income • How much income does the average US household earn in a year? • - statistics will be found for “median” or “mean” • income • Median Income: • - rank all households by income • - household in the middle of distribution • Mean Income: • - add up all household’ income • - divide by number of households

  5. How much are US median income and mean income? median income = $49,777 mean income = $67,976 How much is Colorado’s median income? $55,930 (This was 2009 data) For recent data: US Census Bureau www.census.gov For occupation / industry data: Bureau of Labor Statistics www.bls.gov

  6. Income comes from other sources than working. Employment Projections Program, U.S. Department of Labor, U.S. Bureau of Labor Statistics

  7. How is income spent? Employment Projections Program, U.S. Department of Labor, U.S. Bureau of Labor Statistics

  8. II. What determines income from working? A. Human Capital B. State of the Economy A. Human Capital encompasses a person’s knowledge, ability, and skills. Most human capital is built through education and training. Generally speaking, higher human capital is correlated with higher income.

  9. Educational Attainment--People 25 Years Old and Over, by Total Money Earnings in 2008 US Census Bureau / BLS: 2009 Current Population Survey, Annual Social and Economic (ASEC) Supplement Table from PINC-03

  10. Investing in human capital has an opportunity cost: When students are in class they aren’t being productive in the economy. Increasing human capital can have benefits: - higher paycheck - better society - productive workers

  11. Individuals, firms and governments are willing to pay the costof investing in building human capital because they expect to see benefitsin the future. Governmentsfund public education because a better educated population contributes to faster and sustainable development. Firms invest in employee training because they expect to cover the costs through higher profits from higher worker productivity. Individuals spend time and money on higher education because they expect to earn higher wages.

  12. A degree or certification can signalthat someone has likelybuilt their human capital.

  13. There may *not* be a return on education if - it is of low quality - the knowledge/skills learned don’t match market demand - there is slow economic growth (low demand for new workers) - workers are paid the same regardless of skill (centrally planned economies, bureaucratic systems)

  14. Unemployment Rates by Educational Attainment (people age 25 and older) Less than High School High School Some college or AA 4 year degree or higher www.bls.gov

  15. B. The state of the economy affects income When the economy is doing well, firms are hiring, people find it relatively easy to find jobs. The type of jobs needed in the economy change over time as the structure of the economy changes. If you are skilled in a sector that becomes obsolete, you will need to acquire new skills to work in a different sector or you will be unemployed for a long time.

  16. The US Business Cycle Data source: Bureau of Economic Analysis bea.gov

  17. Economic growth is calculated as: • %ΔRGDP = RGDP2 – RGDP1 x 100 • RGDP1 • where RGDP is Real Gross Domestic Product • dollar value of economic activity • inflation adjusted

  18. 2005 RGDP 2006 RGDP China: ¥7,898.742 b ¥8,743.908 b US: $11,048.625 b $11,413.625 b Calculate each country’s growth rate from 2005 to 2006. China’s growth rate2006 = 8743.908b – 7898.742b x 100 7898.742b = 10.7% US’s growth rate2006 = 11413.625b – 11048.625b x 100 11048.625b = 3.3%

  19. III. A Simple Model of the Labor Market The market wage is determined by the supply and demand for labor. A. The Supply of Labor (workers) Because time is limited, many individuals face a tradeoff between working and not working. - all time spent not working will be called leisure Economists call this the leisure-labor tradeoff. We often analyze it in terms of income earned vs time spent not working.

  20. Income Earned theoretical maximum income Represents all possible income-leisure tradeoffs for a given wage rate. $ from 90 hours of work $ from 40 hours of work Weekly Hours of Leisure $0 0 78 128 168

  21. For a given wage, individuals have different preferences over income and leisure. Person who prefers more income and sacrifices leisure. Person who prefers more leisure and sacrifices income. Income Income Preference Curve Preference Curve Hours of Leisure Hours of Leisure

  22. When the wage increases, people typically respond in two ways: 1. As the wage increases, the opportunity cost of leisure also increases so people work more. - for every hour you are *not* working, you are forgoing more money 2. As the wage increases high enough, the individual has more money and begins to value leisure more and thus works less. We can illustrate this effect with a labor supply curve.

  23. The Labor Supply Curve http://en.wikipedia.org/wiki/Labour_economics As the wage rate increases, first people choose to work more hours, then they choose to work fewer hours.

  24. B. The Demand for Labor (firms) The demand for labor is known as a derived demand because labor is not needed unless there is demand for the product being produced. When a firm hires a worker, the firm incurs a cost but also receives a benefit. - the cost of the worker is the wage - the benefit of the worker is the output the worker produces times the price the firm can sell that output for Ideally, a firm would pay a worker a wage that is equal to the value of the worker’s output.

  25. If the wage were less than the value of output a firm could get from hiring another worker, the firm would want to hire another worker. If the wage were more than the value of output a firm could get from its workers, the firm would want to fire a worker. In general, the lower the wage, the more workers a firm could hire.

  26. Wage Rate As the wage rate falls, a firm can hire more workers. Labor Demand Number of Workers

  27. C. Putting Supply and Demand Together The supply and demand for labor interact to determine the market wage for various occupations. Wage Rate Labor Supply market wage Labor Demand actual workers hired Number of Workers

  28. Ex: The demand for dental services has remained pretty stable while many new dental hygienists are graduating. Wage Rate Labor Supply Two potential outcomes: 1. the wage falls, the new workers are hired New Labor Supply market wage new wage Labor Demand actual workers hired Number of Workers more workers hired

  29. 2. dental offices are already hiring the number of hygienists that are needed, new hygienists are unemployed The wage may or may not fall. Wage Rate Labor Supply New Labor Supply market wage Labor Demand actual workers hired Number of Workers hygienists who want to work

  30. Ex: Professional Engineer vs Bartender Labor Supply Wage Rate Wage Rate Labor Supply Labor Demand Labor Demand Number of Workers Number of Workers

  31. Often times firms will pay a wage that is above the market wage. - attract better workers - reduce turnover Sometimes workers unionize and collectively bargain for wages that are higher than the market wage.

  32. IV. Taxes Individuals Pay • 1. Federal Taxes • Income Tax • Payroll Taxes • The Social Security tax (FICA) 6.2% • The Medicare Tax 1.45% • Estate Tax • Gift Tax • Gasoline Tax 18.4cents per gallon

  33. Calculating your Federal Income Tax 1. compute gross income - wages, salaries - interest, dividends, rental income

  34. 2. compute adjusted gross income subtract off: - retirement savings contributions - alimony - educator expenses - contributions to HSAs - job-related moves expenses - interest paid on student loans - if self-employed: - health insurance premiums - 50% of paid payroll taxes

  35. 3. Subtract any exemptions - fixed amount of money that is deducted for the taxpayer, spouse, dependents - indexed for inflation 2011: $3,700 per person

  36. 4. Decide on deduction type Standard Deduction: $11,600 for married couples filing jointly $5,800 for singles $5,800 for married individuals filing separately $8,500 for heads of household

  37. Itemized Deduction: - medical and dental expenses exceeding 7.5% of AGI - other taxes paid (state, local income tax) - interest on mortgage - charitable donations - casualty and theft losses - union dues and job travel expenses

  38. 5. Compute Federal Income Tax Owed Here are the tax brackets for a single person for 2011: Marginal Tax Tax Bracket Rate over but not over 10% $0 $8,500 15% $8,500 $34,500 25% $34,500 $83,600 28% $83,600 $174,400 33% $174,400 $379,150 35% $379,150

  39. Suppose you are single in 2011 and your AGI is $50,000. Marginal Tax Tax Bracket Rate over but not over 10% $0 $8,500 15% $8,500 $34,500 25% $34,500 $83,600 28% $83,600 $174,400 33% $174,400 $379,150 35% $379,150 On the first $8500, you pay 10% in taxes. 8500 x 0.10 = 850

  40. Marginal Tax Tax Bracket Rate over but not over 10% $0 $8,500 15% $8,500 $34,500 25% $34,500 $83,600 28% $83,600 $174,400 33% $174,400 $379,150 35% $379,150 On the next portion of income, you pay 15% in taxes. 34500 – 8500 = 26000 26000 x 0.15 = 3900

  41. Marginal Tax Tax Bracket Rate over but not over 10% $0 $8,500 15% $8,500 $34,500 25% $34,500 $83,600 28% $83,600 $174,400 33% $174,400 $379,150 35% $379,150 On the next portion of income, you pay 25% in taxes. 50000 – 34500 = 15500 15500 x 0.25 = 3875

  42. The total amount you pay in taxes is: = (0.10)(8500) + (0.15)(34500-8500) + (0.25)(50000-34500) = 850 + 3900 + 3875 = 8625

  43. The marginal tax rate is the tax rate paid on an additional dollar of income. If your AGI is $50,000 and then you earn one extra dollar of income, that dollar is taxed at a rate of 25%. Your current marginal tax rate is 25%.

  44. The average tax rate is the total taxes paid, divided by total income. = 8625 / gross income x 100 Suppose your gross income is $60,000. = 8625 / 60000 x 100 = 14.4% is your average tax rate

  45. 2. Colorado State Taxes for Individuals Income Tax (4.63%) Sales Tax (2.9%) Consumer Use Tax (purchases that did not include Colorado sales tax … internet, mail order, phone) (2.9%) Estate and Trust Income Tax (4.63%)

  46. Gasoline Tax (22cents per gallon) Cigarette Tax (4.2cents per cigarette, 2.9% per pack, 40% on other tobacco products) Alcohol Tax (8cents per gallon beer/cider, 7.33cents per liter wine, 60.26cents per liter of spirits)

  47. 3. Local Taxes and Fees Motor Vehicle Registration Property Tax City Sales Tax 4. Special District Taxes RTD levies a sales/use tax of 1.0% . The Football District has a 0.1% sales/use tax. The Scientific and Cultural Facilities District has a 0.1% sales/use tax.

  48. How your taxes are spenthttp://www.whitehouse.gov/taxreceipt 1. Federal

  49. 2. Colorado http://www.colorado.gov/taxtracks/

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