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Understanding Tax Systems & Government Funding

This chapter explores the structure of tax systems, different types of taxation, and the sources of government funding. It also discusses the most important federal taxes and their implications. Gain insights into tax rates, tax burdens across households, and the financing of social security.

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Understanding Tax Systems & Government Funding

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  1. Chapter 6 Funding the Public Sector

  2. Introduction In recent years, various U.S. politicians and pundits have called for boosts in tax rates for higher-income individuals and tax cuts for middle- and lower-income individuals. How much should income tax rates vary across households based on their incomes? Are tax rates currently low for higher-income households relative to those faced by lower-income households? To evaluate these questions, you must understand more about the structure of tax systems.

  3. Paying for the Public Sector Three sources of government funding Fees, or user charges Taxes Borrowing (bonds) • Government Budget Constraint • The limit on government spending and transfer payments • Every dollar spent must be provided for by taxes

  4. Systems of Taxation (cont'd) Marginal Tax Rate The change in the tax payment divided by the change in income Change in taxes due Change in taxable income Marginal tax rate = • Average Tax Rate • The total tax payment divided by total income

  5. Systems of Taxation (cont'd) Proportional Taxation A tax system in which, regardless of an individual’s income, the tax bill comprises exactly the same proportion

  6. Systems of Taxation (cont'd) Proportional taxation Marginal tax rate = Average tax rate Income Rate Tax liability $10,000 20% $2,000 $100,000 20% $20,000

  7. Systems of Taxation (cont'd) Progressive Taxation A tax system in which, as income increases, a higher percentage of the additional income is paid as taxes

  8. Systems of Taxation (cont'd) Progressive taxation: income tax Marginal tax rate > Average tax rate Income Rate Tax liability $0–$10,000 5% $500 $10,001–$20,000 10% $1,000 $20,001–$30,000 30% $3,000 $4,500

  9. Systems of Taxation (cont'd) Regressive Taxation A tax system in which as more dollars are earned, the percentage of tax paid on them falls

  10. Systems of Taxation (cont'd) Regressive taxation: Social Security Marginal tax rate < Average tax rate Income Rate Tax liability $50,000 10% $5,000 $100,000 5% $5,000

  11. The Most Important Federal Taxes Question What types of taxes do federal, state and local governments collect? Answers Federal government: individual income taxes, corporate income taxes, Social Security taxes, import and excise taxes State and local governments: sales taxes, property taxes, personal and corporate income taxes

  12. Figure 6-1 Sources of Government Tax Receipts Source: U.S. Department of Commerce, Bureau of Economic Analysis.

  13. Table 6-1 Federal Marginal Income Tax Rates

  14. The Most Important Federal Taxes (cont'd) Arguments for the progressive tax Redistribution of income Ability to pay Benefits received Counterargument No strong evidence of redistribution

  15. The Most Important Federal Taxes (cont'd) Who really pays the corporate income tax? Tax incidence is distributed among Consumers Stockholders Employees

  16. The Most Important Federal Taxes (cont'd) Social Security taxes Social Security rates today are imposed on earnings up to roughly $105,000. Contributions are 6.2% for employers and 6.2% for employees.

  17. The Most Important Federal Taxes (cont'd) Unemployment taxes Paid by employer 0.6% of first $7,000 of wages for employees earning more than $1,500 States may levy an additional tax up to 3% based on record of the employer

  18. Financing Social Security Today’s seniors are beneficiaries of rapidly increasing levels of federal spending. Probably half of all federal spending will go to the elderly by 2025. Medicare and Social Security Ida Fuller paid $24.75 in SS taxes and got $22,888.92 until the age of 100 in 1975

  19. Financing Social Security (cont'd) Social Security was founded in 1935, as the United States was recovering from the Great Depression. Means of guaranteeing a minimum level of pension benefits Early recipients had high rates of return on their Social Security contributions

  20. Figure 6-6 Projected Social Security Rates of Return for Future Retirees Sources: Social Security Administration and author’s estimates.

  21. Financing Social Security (cont'd) What Will it Take to Salvage Social Security? There are five options to consider Raise taxes Reduce retirement benefit payouts Reduce disability payments Reform immigration policies Find a way to increase the rate of return

  22. Myth #6: Government does what it does, it ain’t my business • Think again … you pay for whatever the government does.

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