ch25_tax_reform - Chapter 25 Fundamental Tax Reform tax...

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Chapter 25- Fundamental Tax Reform tax evasion - illegal nonpayment of taxation tax avoidance - take legal action to reduce tax burden (claim a tax deduction) tax compliance - efforts to reduce the evasion of taxes “…when the 1986 Tax Reform Act required filers to list… the Social Security numbers of dependents over the age of five, 6 million dependents suddenly disappeared from the tax rolls… [over] 11,000 families lost seven or more dependents between 1986 and 1987.” (726) in 1988, “when the tax law required that the Social Security numbers of child care providers be listed before workers could claim their child care tax credits, 2.6 million child care providers disappeared…” (726-727) Theory of tax evasion higher tax rate→ greater benefit to tax evasion→ expect more tax evasion higher penalty for tax evasion→ higher cost to tax evasion→ expect less tax evasion higher probability of getting caught→ higher cost to tax evasion→ expect less tax evasion US (2003)- “tax gap” between taxes owed and taxes paid = $280 billion (16.3% of tax revenue) today- 1% of corporations face an annual audit 2% of self-employed individuals face an annual audit Why should we care about tax evasion ●efficiency loss from tax evasion tax system #1- high tax rates and some tax evasion tax system #2- low tax rates and no tax evasion collect same amount in revenue tax system #1 is less efficient- recall, the marginal DWL rises with the tax rate plus- cheating rises with the tax rate (raising tax rate to offset revenue loss from cheating is partially self-defeating) ●vertical equity rich have greater scope for tax evasion than the poor why? much of income earned by rich is in forms not directly reported to IRS most income taxes owed by poor are directly withheld from their wages reduce tax evasion→ improve vertical equity ●horizontal equity clear violation if two individuals with same income pay different amounts of taxes because one cheats and the other does not
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Improving tax efficiency How does changing the tax rate change tax revenues ? Changing the tax rate changes tax revenues through five channels: #1) direct effect - a higher tax rate raises revenues on a fixed base of income #2) indirect effects a) gross income effect (↑t→↓ economic activity) A higher tax rate reduces gross income generated by lowering the amount of labor supplied or savings undertaken… (if SE > IE) b) reporting effect (↑t→ take more compensation in the form of nontaxable income) For a given level of gross income, a higher tax rate will cause individuals to reclassify income in ways that are not subject to a tax. EX) $5000 raise or health benefit worth $3000 (not part of taxable income) t= 0.25? t=0.5?
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This note was uploaded on 09/13/2009 for the course PAM 2040 taught by Professor Lewis during the Spring '07 term at Cornell.

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ch25_tax_reform - Chapter 25 Fundamental Tax Reform tax...

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