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Unformatted text preview: Before we start Before Sign the attendance sheet Switch off your cell phone Get ready for a quiz Principles of Taxation Principles Instructor: Instructor: Oksana Alexandrovna Korneo, MBA Oksana [email protected] Office #307, Dostyk Building Based on Principles of Taxation for Business and Investment Planning by Sally M. Jones Based Principles Tax policy - as a government's attitude, objectives, and actions with respect to its tax system with Standards for a Good Tax Standards A GOOD TAX SHOULD BE: GOOD • • sufficient to raise the necessary government revenues convenient for the government to administer and for people to pay • • efficient be fair in economic terms A Tax Should be Sufficient Sufficient A tax is sufficient if it generates enough funds to pay for the public goods and services provided by the government levying the tax. TAX REVENUE >= GOVERNMENT SPENDING What if TAX REVENUE < GOVERNMENT SPENDING? revenue shortfall NON-TAX Revenue: • legalized gambling • selling energy generated by federally own dams • selling mineral or timber rights with respect to federal lands • borrowing money (U.S. treasury bills or bonds) Tax should be sufficient National Debt National $ 14,3 trillion dollars dollars Kazakhstan – 15,9% of GDP USA – 58,9% of GDP Zimbabwe – 241,6% (all – 2010 estimates) http://www.brillig.com/debt_clock/ Tax should be sufficient The promises of yesterday are the taxes of today. ~William Lyon MacKenzie ~William Tax should be sufficient How to Increase TAX revenue? How Exploit a new tax base Increase rate of an existing tax Enlarge an existing tax base Tax should be sufficient Sales Tax – some U.S. States Sales State Sales Tax Alabama 4% Alaska 0.0% Arizona 6.6% Arkansas 6% California 8.25% Colorado 2.9% District of Columbia 6.0% Groceries Prepared Food 2% 10.0% Prescr. Drug Non-prescr. Drug Clothing Tax should be sufficient Static versus Dynamic Forecasting TAX = Rate x Base TAX For the last 10 years, the city of Fairview has levied a hotel occupancy tax equal to 10 percent of the price of a room. In the prior fiscal year, this tax yielded $800,000 revenue. Base = $ 800,000 : 10% = $ 8,000,000 At the beginning of the fiscal year, the city increased the tax rate to 12% TAX = $ 8,000,000 x 12% = $ 960,000 STATIC FORECASTING Tax should be sufficient Static versus Dynamic Forecasting Static TAX = Rate x Base TAX Unfortunately, business travelers and tourists reacted to the additional cost repre-sented by the higher room tax by purchasing fewer accommodations from Fairview hotels. Occupancy rates fell, and annual hotel receipts declined by $500,000. TAX = $ 7,500,000 x 12% = $ 900,000 DYNAMIC FORECASTING – projections, which assume a correlation between rate and base Tax should be sufficient Behavioral Responses to Changes Behavioral in the Income Tax Rate in Mr. Spivey, who earns $25,000 a year as a factory worker and pays 20 percent of that income ($5,000) in tax. Mr. Spivey spends every penny of his $20,000 after-tax income to make ends meet. The government increases the tax rate to 30 percent, thereby reducing his disposable income to $17,500. How would Mr. Spivey react? INCOME EFFECT Ms. Hoover works 60 hours a week as a self-employed management consultant, earning annual income of $350,000. At a 20 percent tax rate, her after-tax in-come is $280,000—more than enough to support her comfortable lifestyle. How would Ms. Spivey react to the same tax increase? SUBSTITUTION EFFECT Tax should be sufficient Supply-Side Economics Supply-Side Faith in the substitution effect is the foundation for supply-side economic theory. Supply-side economics is a school of macroeconomic thought that argues that economic growth can be most effectively created by lowering barriers for people to produce (supply) goods and services, such as adjusting income tax and capital gains tax rates, and by allowing greater flexibility by reducing regulation A Tax Should be Convenient Convenient • Clearly understandable for the taxpayers and convenient to pay • No intrusion into taxpayer’s privacy, but minimum opportunity for noncompliance • Total revenue generated has to significantly exceed administrative cost of collecting and enforcing the tax 2004: Tax revenue - $2,019 billion IRS operation cost - $9,76 billion 0,48 cents per each $100 of revenue A Tax Should be Efficient Efficient Two Approaches: Two 1. Efficient tax is neutral in its effect on the free market. "an old tax is a good tax." 2. Efficient tax is an instrument which enables the government to move the economy in the desired direction. Adam Smith vs. John Maynard Keynes Tax should be efficient Taxes and Behavior Modification Taxes Governments can promote behavioral change by writing tax laws to penalize those who engage in undesirable behavior or reward those who behave in the desired manner. The penalty takes the form of a higher tax burden, while the reward is some type of tax relief. Undesirable Behavior To discourage: an excise tax on ozone-depleting chemicals produced or exported into the United States. To encourage: the lucrative tax break for the construction of pollution control facilities (for instance, wastewater purification plans Desirable Behavior To encourage: reduction of the annual tax bill by the percentage of the cost of renovating a certified historic structure or nontaxable interest on state and local debt obligations. Tax should be efficient Income Tax Preferences Income Tax Preferences - provisions in the federal income tax system designed as incentives to encourage certain behaviors or as subsidies for targeted activities Preferences are indirect governmental expenditures. Tax preferences are justifiable only if the intended result has merit or deserves public support. They are not included in calculation of any federal operating deficit. They add enormously to the length and complexity of the tax law. Examples $80 billion per year on deductions of home mortgage interest payments $15 billion on deduction of local property tax Tax should be fair A Tax should be Fair Tax Ability to pay - the economic resources under a person's control Dimension of ability to pay: • income taxes are based on a person's inflow of economic resources during the year • sales and excise taxes are based on a person's consumption of resources represented by the purchase of goods and services • real and personal property taxes focus on a person's accumulation of resources in the form of certain types of wealth • transfer taxes are based on the accumulated wealth that a person gives to others during life or at death Tax should be fair Vertical Equity Vertical Horizontal equity - if a tax is designed so that persons with the same ability to pay (as measured by the tax base) owe the same amount of tax. Horizontal equity is concerned with a rational and impartial measurement of the tax base Example: sales tax Vertical Equity - if a tax is designed so that if persons with a greater ability to pay owe more tax than persons with a lesser ability to pay. Vertical equity is concerned with a fair rate structure by which to calculate the tax on different amounts of base Example: property tax with graduated rate Tax should be fair Horizontal Equity Horizontal Mr. A Mr. B Single Single Annual salary $40,000 Annual salary $40,000 No other income No other income Do they have the same ability to pay income tax? Chronic illness - $7,000 uninsured medical expenses Perfect health Never been married Alimony - $3,850 The horizontal equity of the income tax is enhanced by refining the calculation of taxable income to include the significant variables affecting a person's economic circumstances for the year. Annual vs. Lifetime Horizontal Equity Horizontal Tax should be fair Mr. G Mr. T Blue-collar worker Scion of a wealthy family annual taxable income $25,000 Annual income from interest and dividends from a trust fund $225,000 Won a $200,000 lottery jackpot The same taxable income for the current year ! Tax Preferences and Horizontal Equity Horizontal Tax should be fair Mr. J Mr. M Investor Investor annual profit $20,000 annual profit $20,000 No tax preferences Some tax preferences Taxable income $20,000 Taxable income $14,000 This example suggests that tax preferences can distort This the horizontal equity of the income tax. the Tax should be fair Vertical Equity Vertical Percentage Rate 2% 1% Bracket Assessed value from 0 - to $1 million Assessed value in excess of $1 million Mr. Foley owns real property with an assessed value of $500,000 Ms. Lennon owns real property with an assessed value of $1.5 million Mr. Foley $500,000 *2% = $10,000 Ms. Lennon $1,000,000*2% + $500,000 *1%= $25,000 Regressive Taxes Tax should be fair Regressive rate structure – graduated rates that decrease as the base Regressive increases Ms. Lennon: Mr. Foley: $25,000 tax / $1,500,000 base = 1.667% average tax rate $10,000 tax tax / $500,000 base = 2% average tax rate Mr. James and Mr. Kim live in Maryland, which has a 5 percent sales tax on all retail purchases. Mr. James earns $20,000 annual disposable income and spends this entire amount on taxable purchases. Mr. Kim earns $100,000 annual disposable income, spends only $75,000, and invests the remaining $25,000 Mr. James: $20,000*5% = $1,000 tax $1,000 tax / $20,000 base = 5% average tax rate Mr. Kim: $3,750 tax / $100,000 base = 3.75% average tax rate Tax should be fair Income Tax Rate Structures Proportionate Rate (10%) Proportionate Taxable Income Taxpayer A Taxpayer В Taxpayer С Total Tax $ 20,000 $ 45,000 $ 100,000 $ 2,000 $ 4,500 $ 10,000 $16,500 The theory of the declining marginal utility of income: financial importance declining associated with each dollar of income diminishes as total income increases Tax should be fair Income Tax Rate Structures Progressive Rate Structure Percentage Rate 5% 10% 16% Bracket Income from 0 to $20,000 Income from $20,000 to $50,000 Income in excess of $50,000 Taxable Income Taxpayer A Taxpayer В Taxpayer С Total Tax $ 20,000 $ 45,000 $ 100,000 $ 1,000 $ 3,500 $ 12,000 $16,500 Marginal and Average Tax Rates Marginal An average tax rate is the ratio of the amount of taxes paid to the tax base The marginal rate is the rate that applies to the next (or last) dollar of taxable income. Taxpayer B Marginal rate – 10% Average rate – 7,8% ($3,500 / $45,000) Proportional rate structure Marginal rate = Average rate Progressive rate structure Marginal rate = Average rate Distributive Justice 1. Taxes appropriate private wealth for public use, and typically appropriate a greater amount from the rich than from the poor. 2. Therefore, taxes become mechanisms for the redistribution of wealth across society. 3. The justification for a progressive income tax is its potential for rectifying distributive inequity. The more progressive tax structure – the more justice? The Perception of Inequity The The most widespread complaint against the federal income tax system is that it is unfair. Individuals. who are convinced that the income tax system is inherently unfair are more likely to deliberately underreport their taxable incomes Many individuals believe that the income tax system is unfair because it is so complicated. ...
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This note was uploaded on 12/14/2011 for the course ECONOM 110 taught by Professor Tuturukov during the Spring '11 term at London College of Accountancy.

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