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Chapter Introduction

Section 1: The Economics of Taxation

Section 2: Federal, State, and Local Revenue Systems

Section 3: Current Tax Issues and Reforms

Visual Summary

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Chapter Intro-End

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Section 1

Economic Impact of Taxes (cont.)

• Taxes and other governmental revenues influence the economy by affecting

– Resource allocation

– Behavior adjustment

• Sin tax


Section 1

Economic Impact of Taxes (cont.)

– Productivity and growth

– Determining incidence of a tax

Shifting the Incidence of a Tax


Section 1

Criteria for Effective Taxes (cont.)

• Taxes must meet three criteria:

– Equity—impartial and just: Makes sense to avoid tax loopholes

– Simplicity—tax laws written so taxpayers and collectors can understand them

• Individual income tax—complex tax

• Sales tax—simpler


Section 1

Criteria for Effective Taxes (cont.)

– Efficiency—easy to administer and successful in generating revenue

• Individuals file a tax return before April 15th each year.


Section 1

• United States taxes are based on two principles

– Benefit principle of taxation

Two Principles of Taxation (cont.)

• Limitations to the benefit principle of taxation

• Those who receive government services are least likely to afford them.

• Benefits are hard to measure and impact others.


Section 1

– Ability-to-pay principle of taxation

• We can’t always measure benefits derived from government spending.

• Assumes individuals taxed more suffer less discomfort paying taxes

Two Principles of Taxation (cont.)


Section 1

• Three general types of taxes exist in the United States today.

– Proportional tax

Three Types of Taxes (cont.)

• If the percentage tax rate is constant, the average tax rate is constant.

• Medicare tax fund

Three Types of Taxes


Section 1

– Progressive tax

• Marginal tax rate

Three Types of Taxes (cont.)

– Regressive tax

Profiles in Economics:

Monica Garcia Pleiman


Section 1-End


Section 2

Federal, State, and Local Revenue Systems

• The Internal Revenue Service (IRS) is the branch of the U.S. Treasury Department in charge of collecting taxes today.


Section 2

Federal Government Revenue Sources(cont.)

• Four largest sources of government revenue are

– Individual income taxes

• Tax is mostly collected through a payroll withholding system.

• Tax code takes into account indexing.

Federal Government Revenue Sources


Section 2


– FICA or Federal Insurance Contributions Act tax

• Social Security and Medicare are part of payroll taxes.

– Borrowing by selling bonds to investors

– Corporate income tax

– Excise tax

The Global Economy & YOU

Total Tax Revenue as a Percentage of GDP


Section 2


– Estate tax and gift tax

– Customs duty

– Miscellaneous fees like a user fee


Section 2

• Largest sources of state governments revenue

– Intergovernmental revenue

– Sales tax implemented by most states

– Individual income taxes by most states

– Other revenue sources

State Government Revenue Sources(cont.)

State and Local Government

Revenue Sources


Section 2

• Largest sources of local governments revenue

– Intergovernmental transfers from state and federal governments

– Property tax

Local Government Revenue Sources(cont.)

• Tax assessor determines valuations of property

State and Local Taxes

as a Percentage of State Income


Section 2

– Utility revenues from natural monopolies

– Sales tax

– Other revenue sources

Local Government Revenue Sources(cont.)


Section 2-End


Section 3

Examining Your Paycheck (cont.)

• The payroll withholding statementattached to your paycheck lists deductions taken.

Biweekly Paycheck

and Withholding Statement


Section 3

• The Economic Recovery Tax Act, signed by Ronald Reagan in 1981, included large tax reductions for individuals and businesses.

• Businesses also got tax relief from accelerated depreciation and investment tax credit.

Tax Reform (cont.)

Tax Table for Single Individuals, 2006


Section 3

• In 1983 the alternative minimum tax was passed.

• In 1993 government added tax brackets in order to balance the budget.

• The Taxpayer Relief Act of 1997 was both economical and political.

Tax Reform (cont.)

– Capital gains tax was reduced.

Total Government Receipts

per Capita, Adjusted for Inflation


Section 3

• Temporary tax reform in 2001—based on the federal government collecting more taxes than it was spending

• Temporary tax reform in 2003—due to slow economic growth, accelerated many of 2001 reforms

• If the present trend of government spending more than it collects in taxes continues, it will be difficult to preserve tax cuts due to expire in 2011.

Tax Reform (cont.)


Section 3

• Two alternative forms of taxation

– Flat tax

– Value-added tax (VAT)

Alternative Tax Approaches (cont.)

The Value-Added Tax


Section 3

• Advantages to the flat tax

– Simplicity to taxpayer

– Closes most loopholes

– Reduces need for many workers in IRS and tax preparers



Section 3

• Disadvantages to the flat tax

– Removes many incentives built into current tax code

– Don’t know what rate is needed to replace revenues collected today

– Unsure if flat tax would stimulate economic growth



Section 3

• Advantages to the VAT

– Tax is hard to avoid

– Tax incidence is widespread

– Easy to collect

– Encourages saving



Section 3

• Disadvantage to the VAT

– Virtually invisible—other factors can change the product’s price.


• Desires to simplify the tax code, unexpected expenditures on war and natural disasters, and political change all result in tax reform.


Section 3-End

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