Chapter 9:Sources of Government

Revenue

Chapter 9:Sources of Government

Revenue

9-1: The Economics of Taxation

• Economic Impact of Taxes– Resource allocation – when taxes are raised

on a product, consumers buy less, manufacturers produce less, and resources will have to go to other industries to be employed

– Behavior adjustment - taxes can be used to encourage or discourage certain types of activities

– By changing incentives to save, invest and work, taxes affect productivity and growth

• Criteria for Effective Taxes– Equity - fair– Simplicity – easy to understand– Efficiency – benefits outweigh costs

• Two Principles of Taxation:– Benefit Principle – belief that taxes should be paid

based on benefits received, regardless of income– Ability to Pay Principle – belief that taxes should be

paid according to the level of income, regardless of benefits received

Three Types of Taxes1. Proportional Tax – as income goes up, the percentage of income paid in taxes stays the same2, Progressive Tax – as income goes up, the percentage of income paid in taxes goes up3. Regressive Tax - as income goes up, the percentage of income paid in taxes goes down

9-2: Federal, State, and Local Revenue Systems

Federal Government Revenue Sources (in order of size)1. Individual Income Taxes

– collected with a payroll withholding system that automatically deducts income taxes from

paychecks2. FICA Taxes - Federal Insurance Contributions Act

- tax levied on employers and employees to support Social Security and Medicare

- also automatically deducted from paycheck3. Borrowing4. Corporate Income Taxes5. Excise Taxes – tax on manufacture or sell of selected

items such as gasoline and liquor

6. Estate and Gift Taxes7. Customs Duties8. Miscellaneous Fees

State Government Revenue Sources (in order of size)1. Intergovernmental Revenues

– funds collected by one level of government that is distributed to another level of government for

expenditures2. Sales Taxes

- general tax levied on consumer goods- 5 states do not have a general sales tax

3. Individual Income Taxes- only 7 states do not rely on individual income

taxes for revenue- varies widely from state to state

4. Other Revenues- interest earnings- tuition and fees- corporate income taxes

Local Government Revenue Sources (in order of size)1. Intergovernmental Revenues2. Property Taxes

- tax on tangible and intangible possessions such as real estate, buildings, furniture, stocks, bonds and bank accounts3. Utility Revenues

- public utility companies that supply water, electricity, sewer, and sometimes telecommunications are often owned by local governments4. Sales Taxes5. Other Revenue Sources

- interest earnings- fees- borrowing

9-3: Current Tax Issues and Reforms

• Current Tax Code is incredibly complex

• Tax Reform: 1981– Economic Recovery Tax Act included large tax

deductions for individuals and businesses, accelerated depreciation, and investment tax credits

• Tax Reform: 1986• Tax Reform: 1993• Tax Reform: 1997• Tax Reform: 2001• Tax Reform: 2003• Permanent tax cuts by 2011?

Alternative Tax Approaches

• Flat Tax – a proportional tax on individual income– Simple– Closes “loopholes”– Save $$ and time preparing tax returns– Removes incentives in current tax code

• Value-Added Tax – Tax consumption, not income– Equivalent to a national sales tax– Tax on the value added at every stage of the

production process