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Ch2 - Chapter 2 Tax Policy Issues Standards for a Good Tax...

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Unformatted text preview: Chapter 2 Tax Policy Issues: Standards for a Good Tax The Standards for a Good Tax Income and Substitution Effects Equity Issues Tax Rate Structure Tax Policy Issues "The art of taxation consists in so plucking the goose as to obtain the largest possible amount of feathers with the least possible amount of hissing." Jean Baptiste Colbert Tax Policy Issues Standards for a Good Tax In theory every tax can and should be evaluated on a set of basic standards. In general a tax should be: Sufficient Convenient Efficient Fair Tax Policy Issues - Sufficiency A Sufficient Tax A tax is sufficient if: it generates enough funds to pay for the public goods and services provided by the government levying the tax. www.cbo.gov www.publicdebt.treas.gov/opd/opdpenn Q2 Forecasting revenue: Static forecast Dynamic forecast Tax Policy Issues - Sufficiency Income versus Substitution Effects Remember tax = rate x base What affect on behavior does a change in either rate or base have? Tax Policy Issues Sufficiency Income Effect: Tax increase ==> base increase Tax decrease ==> base decrease Work to keep after-tax income the same. Q5 Tax Policy Issues - Sufficiency Substitution Effect: Tax increase ==> base decrease Tax decrease ==> base increase Substitute between labor and leisure. The income effect is more powerful for lower-income taxpayers and the substitution effect is more compelling to higher-income taxpayers. Q6, AP1 Tax Policy Issues - Convenience A Convenient Tax A tax is convenient if: Government's View Taxpayer's View Tax Policy Issues - Efficiency A tax is efficient if: judged by the classical standard of efficiency, it does not distort the market, create suboptimal allocation of goods and services, or modify taxpayer behavior. judged by Keynesian standards it is an effective fiscal policy tool for regulating the economy. Tax Policy Issues - Equity A tax is fair if: the taxpayer has the Ability to Pay the tax. it enhances Horizontal Equity enhances Vertical Equity it Tax Policy Issues - Equity Horizontal Equity Achieving horizontal equity depends heavily on the tax base definition. Tax `loopholes' vary across taxpayers. A simple but unpopular solution is to eliminate all tax preferences. Tax Policy Issues Vertical Equity What should rate structure look like? The ongoing policy issue is usually not whether rich should pay more taxes than poor, but how much more is appropriate. The definition of how much "more" is, may result in a tax rate structure that is regressive, proportional, or progressive. Tax Policy Issues - Equity Regressive: tax rate decreases as tax base increases. Smith pays $2,000 tax (10%) on income of $20,000 and Jones pays $3,000 tax (5%) on income of $60,000. pays $2,000 tax (10%) on income of $20,000, and Jones pays $6,000 tax (10%) on income of $60,000. Proportional = flat tax rate Smith Progressive: tax rate increases as tax base increases. Smith pays $2,000 tax (10%) on income of $20,000, but Jones pays 12,000 (20%) on income of $60,000. Tax Policy Issues Tax Rate Structure Average Tax Rate = Tax Rate = Marginal Q17 ...
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