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Chapter 12

Chapter 12 Economics.docx

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Economics 10a
Gregory Mankiw

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Chapter 12 Economics: The Design of the Tax System • All taxes (income, corporate income, payroll, sales, and property) all use up a third of the averageAmerican’s income • As the economy’s income has grown, the government’s revenue from taxation has grown even more • Less economically developed nations like India, China, Chile, and Mexico tend to have lower tax burdens • Western Europe tends to have higher tax burdens • Government revenue through taxes: approximately $6,846 per individual • The sources of revenue for the federal government in descending order is the individual income tax, social insurance taxes (payroll taxes), corporate income taxes, and other • The family’s tax liability (how much it owes) is based on the total income (including wages, interest on savings, dividends from stocks, profits from small businesses, etc.) • April 15 is tax day • Taxable income=total income – number of dependents (usually children) – deductible expenses (i.e. mortgage interest payments, state and local tax payments, and charitable giving) o Tax liability is determined from a schedule  Marginal tax rate: the tax rate applied to each additional dollar of income  Tax rate rises as income rises  The tax rate in the schedule applies to income within the associated range • If you make $1 million, then your first $8,375 is taxed at 10% • Payroll tax: tax on the wages that a firm pays to its workers that is earmarked to pay for Social Security and Medicare • Corporate income tax: the government taxes a corporation based on its profit (the amount the corporation receives for the goods or services it sells minus the costs of producing those goods or services) o Corporation: a business set up to have its own legal existence, distinct and separate from its owners o Corporations are taxed twice: once by the corporate income tax and once by the individual income tax when the corporation uses its profits to pay dividends to its shareholders  To correct this in part, the tax rate on dividend income was reduced to 15% • Other taxes: Includes excise taxes (which are taxes on specific goods like gas, tobacco, and alcohol), estate taxes, and custom duties • Government spending: approximately $11,441 per individual • The sources of spending of the federal government in descending order: social security, national defense, income security, Medicare, health, net interest, and other • Social Security: represents transfer payments to the elderly o Transfer payment: a government payment not made in exchange for a good or service • National Defense: includes salaries of military personnel and the purchase of military technology (guns, jets, and warships) • Income security: transfer payments to poor families and the unemployed o Welfare (TemporaryAssistance for Needy Families), Food Stamp program, and unemployment compensation o The Federal government pays some of this money to state and local governments, which administer the programs under federal guidelines o This type of spending tends to rise during recession • Health spending includes Medicaid and spending on medical research, though Medicare is its own category • The more indebted the government, the larger the amount that it must spend in interest payments • Other: includes federal court system, space program, farm-support programs, housing credit programs, and salaries of members of Congress and the president • Budget deficit: an excess of government spending over government receipts; the government finances a budget deficit by borrowing from the public (selling government debt into the private sector in the U.S. and abroad) • Budget surplus: an excess of government receipts over government spending; the government uses the excess receipts to reduce its outstanding debt • Recessions tend to increase government spending and decrease government revenue • It is projected that in the future tax revenues will remain about constant, while government spending as a percentage of the GDP is projected to rise gradually but substantially over the next several decades o For example, this is true because transfer payments to the elderly through Social Security and Medicare are only projected to increase as the elderly are a growing percentage of the population (longer life expectancy) o Additionally, the taxable income of the labor force is projected to remain fairly stable as the labor force is growing much more slowly than it has in the past (lower fertility) o Also, healthcare costs are rising, so expenditures on Medicare and Medicaid will rise as well • Abudget deficit just pushes the cost of government spending onto a future generation of taxpayers o Some believe that taxes need to be increased in order to lower the deficit o Others believe that policymakers must reduce the promises being made to the elderly by raising the retirement age, increasing the incentives to save during their working years to prepare for their own retirement and health costs • State and local governments collect about 40% of all taxes paid • In descending order of importance, the sources of state and local government revenue are sales tax, property taxes, individual income taxes, corporate income taxes, from federal government & other (sales tax and property tax comprise more than 1/3 of all receipts) • Sales tax: levied as a percentage of the total amount spent at retail stores (some states exclude necessities like clothing and food) • Property tax: levied as a percentage of the estimated value of land and structures and are paid by property owners • Not all states tax income and some states tax income earned from interest and dividends more than income earned by wages • The Federal government’s policy of revenue sharing allows for a redistribution of funds from high-income states (who pay more taxes) to low-income states (who receive more benefits), particularly if these funds are tied to programs that the federal government wants to subsidize • Other: includes fees for fishing and hunting licenses, tolls from roads and bridges, and fares for buses and subways • In descending order, the spending practices of the state and local governments on programs: education, public welfare, highways, and other • Education: local governments pay for public schools, while state governments contribute to the support of public universities (amounted for a third of state and local government spending) • Public welfare: includes transfer payments to the poor, which are often federal programs administered by state and local governments • Highways: building of new roads and the maintenance of existing ones • Other: includes libraries, police, garbage removal, fire protection, park maintenance, and snow removal • The cost of taxes: o The actual cost to the producer/consumer o The deadweight losses that result when taxes distort the decisions that people make and the incentives of those decisions; it is the reduction in economic well-being of taxpayers in excess of the amount of revenue raise by the government  The DWL is the inefficiency that a tax creates as people allocate their resources according to the tax incentive rather than the true costs and benefits of the goods and services that they buy and sell o The administrative burdens that taxpayers bear as they comply with the tax laws • An efficient tax system is one that imposes small deadweight losses and small administrative burdens, while costing consumers the least amount of money but raising the same amount of
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