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ECON 110 (192)

Taxation and Public Expenditure

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Queen's University
ECON 110
Ian James Cromb

Taxation and Public Expenditure Progressive Tax-tax that takes a larger percentage of income from high-income peole than it does from low-income people -influences the distribution of income-> reduces the inequality of income -expressed in terms of Shares of incomes rather than absolute dollar amounts Proportional Tax-tax that takes a constant percentage of income at all level of income -Lump-Sum Tax Regressive Tax-takes a larger percentage of income from low-income people than it does from high-income people -expressed in terms of Shares of incomes rather than absolute dollar amounts -influences the distribution of income-> increases the inequality of income -some taxes in Canada are highly visible, like income taxes and Goods and Services Tax (GST) -some taxes in Canada are invisible because they don’t show up on income-tax forms or on receipts for purchases, such as special taxes levied on the sales of alcohol, cigarettes, and gasoline-> levied directly on the producers rather than on the retailers -people and firms are taxed on what they earn, on what they spend, and on what they own -taxes takes together raise a large amount of revenue Average Tax Rate-ratio of total taxes paid to total income earned -percentage of income that the individual pays in taxes Marginal Tax Rate-fraction of an additional dollar of income that is paid in taxes -percentage of the next dollar earned that the individual pays in taxes -personal income taxes are paid directly to the government by individuals Total Income-all types of income-> certain types of income qualify for total or partial exemption -number of allowable deductions are subtracted from it to determine taxable income Basic Personal Amount- most important deduction Tax Bracket- range of taxable income where there is a constant marginal tax rate $0-$40,726: marginal tax rate of fifteen percent $40,726-$81,452: marginal tax rate of twenty-two percent $81,453-$126,264: marginal tax rate of twenty-six percent $126,264 and over: marginal tax rate of twenty-nine percent -federal corporate income tax is flat rate (proportional tax) on profits as defined by the taxing authorities which includes the return on capital and economic profits -large businesses are taxed higher than small businesses by federal and most provincial governments Dividend-represents the shareholder’s share of after-tax profits and would ordinarily be taxed along wither their other income -to avoid double taxation on it, individual shareholders get a personal income-tax credit for their share of corporate tax already paid by the firm -some people argue that the corporate income-tax rates should change because they are already low and that firms aren’t paying their ‘fair share’ of the tax burden -some people argue that corporate taxes end up being paid partly by firm’s customers and employees, and partly by the individuals who owns sharers in firms, which now includes most individuals through some form of employer-sponsored or self-administered pension plan, and that corporate taxes, by reducing the rate of return on investment, impede the economy’s long- run growth Excise Tax-tax levied on a particular commodity -in many countries, such goods as tobacco, alcohol, and gasoline have higher rates of excise taxation because they are usually account for a much greater proportion of the expenditure of lower-income than higher-income groups-> regressive tax -referred to as ‘indirect tax’ to contrast them with income taxes, which are levied directly on the income of individuals or firms -levied on the current payment to a factor of production (income) Sales Tax-applies to the sale of all or most goods and services -mildly regressive because poorer families tend to spend a larger proportion of their incomes than richer families -referred to as ‘indirect tax’ to contrast them with income taxes, which are levied directly on the income of individuals or firms -levied on the value of a currently purchased good or service Goods and Services Tax (GST)-advantage is that taxes expenditure rather than income-> doesn’t discourage saving -taxes a firm on the gross value of its output and then allowing a tax credit equal to the taxes paid on the inputs that were produced by other firms -mildly regressive, because proportion of income saved rises with income-> regressivity is reduced by exempting food and by giving low- and middle- income households a refundable tax and credit -for the lowest-income households, it’s a progressive tax because the refundable tax credit exceeds the value of it that they would pay -taxing income is that interest earnings from accumulated savings get taxed, which reduces the capital accumulation for the economy Value Added Taxes (VAT)- Canada introduced GST to levy similar taxes in Europe Economic Profit-difference between firm’s revenue, explicit costs, such as labour, materials, overhead, and depreciation, and the opportunity costs of the owner’s time and financial capital -if the corporate income tax applies to it, firms and their owners bear the entire burden of the tax, but the tax will have no effect on the allocation of resources, and the tax will be efficient Accounting Profit-difference between the firm’s revenue and explicit costs, such as labour and materials -if corporate income tax applies to it, and it results in a negative economic profit, then some of the burden of the tax falls on consumers and workers and some falls on firms and their owners-> higher product prices and low wages-> leads to changes in the allocation of resources and generates some inefficiency -less investment in physical capital-> less adoption of the latest technologies-> lower productivity growth-> slower growth in average living standards -easier to measure-> hard to measure opportunity cost-> most used Property Tax-not related directly to a current transaction -mildly regressive -most important Canadian tax that’s based on wealth and is an important source of revenue for municipalities Cons: -someone has to assess the current market value of the property-> assessment is only an estimate and is always subject to challenge -sometimes owners of valuable property have low incomes, but considerable real estate wealth, and thus have difficulty paying the tax from their available funds Equity -fairness-> normative concept-> definition of fairness is not the same for everyone Ability to Pay Principle Vertical Equity-equity across income groups -focuses on comparisons between individuals or families with different levels of income -requires progressive taxation-> taxes should be based on ability to pay Horizontal Equity-concerns equity within a given income group its concerned with establishing just who should be considered equal to whom in terms of ability to pay taxes-> for example, two households could have the same income but different amounts of expenses such as different number of children Benefit Principle-taxes should be paid tin proportion to the benefits that taxpayers derive form public expenditure -pure public goods? -redistribution among themselves? User Charges-ideal taxes -for example, those would be charged if private firms provided the government service such as a gasoline tax, since gasoline usage is closely related to the services obtained from using public roads How Progressive is the Canadian Tax System? -assessing how the entire tax system affects the distribution of income is complicated: -progressivity of the system depends on the mix of the different taxes-> federal taxes tend to be somewhat progressive-> the progressivity of the income-tax system and the use of a low-income GST tax credit more than offset the regressivity of the federal GST-> provincial and municipal governments rely heavily on property and sales taxes and thus have tax systems that are probably slightly regressive -income from different sources is taxed at different rates-> for example, profits from sales of assets (capital gains) are taxed less than wages and salaries -roughly proportional for middle-income classes and mildly progressive for low- and high-income classes-> redistributing some income from high-income households to low-income households and doing little redistribution among the middle-income households Taxation and Efficiency -tax system influences the allocation of resources by altering such things as the relative prices of various goods and factors and the relative profitability of various industries -individual taxes shift consumption and production toward goods and services that are taxed relatively low and away from those that are taxed high-> alternation of free-market outcomes causes allocative inefficiency-> minimize the amount of excess burden (deadweight loss) for any given amount of tax revenue generated -taxes help pay for government programs and public goods desired by society -relevant objective for tax policies is to design a tax system that minimizes inefficiency, holding constant the amount of revenue to be raised and-> raise revenue and enhance efficiency Direct Burden- for an individual tax, the amount of money collected from taxpayers Excess Burden- allocative inefficiency or deadweight loss generated by a tax -imposing taxes on goods with inelastic demands (life’s necessities, such as food) would be regressive -income tax generates a direct burden and excess burden-> tax raises revenue by collecting some percentage of worker’s wages -> cost borne by workers and firms-> reducing the equilibrium level of employment and creating a deadweight loss, the income tax creates an excess burden-> revenue collected by the tax understates the total cost of the tax Laffer Curve -shows the income-tax rate’s relationship with the amount of work effort -at a zero tax rate, no revenue is collected- > as rates are raised above zero, some revenue will be gained-> rates continue to rise causes revenue to eventually fall because the very high tax rates will lead people to work less and less-> at a tax rate of one hundred percent, workers will not work at all because all their income would go to the government, and so the tax revenue will be zero -government’s stock of debt is equal to the accumulation of its past budget deficits, where the deficit is the excess of spending over revenues Transfer Payments-payment to an individual, a firm, or an organization that isn’t made in exchange for a good or service -for example, federal governments paying employment insurance benefits to an unemployed individual Fiscal Federalism -recognition that Canada is a country with many different fiscal authorities (federal, provincial, and municipal governments) that need a certain amount of coordination to be responsive to the needs and desires of the citizens -differences in tax bases in different provinces-> provinces with a larger tax bases are able to provide a given amount of services while having relatively low tax rates-> less affluent provinces with smaller tax bases are able to provide the same amount of services only by having higher tax rates -one of Canada’s principle is for individuals to have approximately the same access to what is regarded as a reasonable level and quality of public services and should face approximately the same tax rates to finance those services Intergovernmental Transfers-required for revenue sources to match revenue needs Equalization Payments-transfer resources from the richer provinces to the poorer ones
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