Notes:
October 20, 1997
I. Basic overview and description of taxes in the U.S.
Marginal tax rate--tax rate imposed on last
(marginal) dollar of income.
Progressive tax--the percentage of tax paid is higher
for higher-income taxpayers e.g. federal income tax.
- Example: in 1995 the federal income tax rate on the first
$30,000 of income earned was 15%, on income over $30,000,
it was 28%.
-
- Ms. Brown had a job that paid $30,000. How much did she
pay in income taxes?
(.15)($30,000)=$4,500
- Mr. White had a job that paid $65,000. How much did he
pay in income taxes?
(.15)(30,000) +
.28(65,000-30,000)
$4,500 + $9,800 = $14,300
What
was the marginal tax rate for Mr. White? 28%
- What
was the average tax rate for Mr. White?
(14,300) / (65,000) = 22%
Regressive tax--the percentage of tax paid is higher
for lower-income taxpayers, e.g., social security tax.
- Example: Social Security taxes amount to about 15% of all
wage income up to about $50,000.
-
Ms. Smith has a job that pays $50,000. How much
does she pay in Social Security taxes?
(.15) (50,000) =$ 7, 500
What percentage is this of her total income? 15%
- Mr. Jones has a job that pays $ 500,000 and another
$500,000 in income from dividends and interest. How
much does he pay in Social Security taxes? The same as Ms. Smith.
- What percentage is this of his total income?
(7, 500) / (1,000,000) =
.0075 or about 1%
What was the marginal SS tax rate for Mr. Jones? Zero.
-
What was the average SS tax rate for Mr. Jones? 1%
Exemption--money that is exempt from taxation
Deduction--money that can be deducted from taxable
income
- Examples: exemptions for dependent children, spouses, old
age, disabilities; deductions for home mortgage interest,
work-related expenses, child care, depreciation of
investments
Nominal tax rate--taxes as a percentage of TAXABLE
income (income less exemptions and deductions)
Effective tax rate--taxes as a percentage of total
income without regard to exemptions and deducations
- Back to Ms. Brown, who earned $30,000. Her nominal income
tax rate, if you remember, was 15%.
- Her deductions and exemptions totaled $10,000.
- How much tax did she actually pay?
(.15) (20,000)= $3,000
- What was her effective income tax rate?
(3,000) / (30,000) =.10 or 10%
This will be important when we look at the flat tax
State and Local Taxes
Sales Taxes--a tax on consumption, rather than on
income nominal tax rate is the same for everyone (around 5%), but
effective tax rate differs because some people spend all their
income and some don't.
- Example: Family 1 has an income of $50,000, but spends
only $40,000 a year.
- They pay (.05) (40,000) or $2,000 in sales tax.
What percentage of their income is that?
($2,000)/ (50,000)= 4%
- Family 2 as an income of $15,000, but spends every penny.
They pay (.05) (15,000)= $750.
- What percentage of their income is that? 5%
Property Taxes--a tax on the assessed value of real
estate. Tend to be regressive because:
- --landlords pass property taxes on in form of higher
rents
- --elderly families tend to own their own homes but have
low incomes
- --wealthy people hold a higher percentage of their wealth
in stocks and bonds, which are not subject to local
taxation
Lottery--a "voluntary" tax
- A tax on ignorance. Less-educated people spend a much
higher percentage of their income on it than
more-educated people. Less-educated people tend to have
lower income
-
- The lottery is a highly regressive tax
II. Social Security
An intergenerational contract: the working-age population pays
taxes that support the retired population.
A. Benefits
- Provides benefits to the elderly based on the taxes they
have paid, but benefit structure is slightly progressive
(low wage contributors get slightly more relatively to
their contributions than high wage contributors). The
benefits received are far greater than what people could
have earned by simply putting that money in an
investment, such as the stock market.
-
- Also provides benefits to families of dead or disabled
workers (survivor's insurance)
-
B. Social Security and the Family
- a "socialization" of the obligations of the
traditional patriarchal family
-
- When it was first put into place, there were about 50
people being taxed to provide for each eligible person
over age 65. That ratio has steadily declined: now it is
less than 4 to 1.
-
- Subsidizes housewives (and, since the 1970s,
househusbands); therefore, penalizes working spouses
- Does not recognize the value of parental labor
C. The Future of Social Security
- In the future, it is likely that either tax rates will be
increased, or benefits reduced.
- Much depends on the growth of productivity and wages AND
birth rate.
-
- If fertility levels fall further, problems will be more
serious.
-
- What effect will globalization have? We don't know yet.
III. Are tax cuts good for the economy? The income tax
cuts of the 1980s.
- Taxes are the product of the tax rate times the tax base
- In a simplified model, Gross Domestic Product, the total
value of goods and services produced within the U.S.
(GDP) can represent the tax base
- Taxes = (x%) (GDP)
- Question: what is the relationship between the overall
tax rate, x, and GDP?
- Supply side argument: if you cut x, you will increase GDP
more than enough to compensate, e.g. a smaller slice of a
bigger pie: 35% of a trillion is less than 25% of 2
trillion. This is true.
Laffer Curve:
- Put tax rate on the vertical axis, tax revenues on the
horizontal axis.
- Curve looks like a backwards C.
- Initially as tax rate goes up, tax revenues increase, but
past a certain point, taxes discourage productive
activity, the tax base declines, and revenues fall
-
- In fact the income tax cuts of the1980s did not
significantly increase GDP.
-
- GDP has increased much more rapidly between 1991 and
1997, despite modest income tax increases.
-
- Tax revenues have increased dramatically in recent years
as a result of this economic growth.