ECON FINAL STUDY GUIDE

ECON FINAL STUDY GUIDE - THE DESIGN OF THE TAX SYSTEM Two...

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THE DESIGN OF THE TAX SYSTEM Two objectives of policymakers in designing a tax system: o Efficiency o Equity How Federal Tax System evolved? o Raise Tax Revenue o Be Fair o Influence Behavior: Excise tax on spirits “VOLUNTARY” COMPLIANCE: THE INTERNAL REVENUE SERVICE(IRS) o “A system of cpmliance that relies on individual citizens to report their income freely and voluntarily, calculater their tax liability correctly, and file a tax return on time” o Voluntary : the income tax system: Means that you can minimize your taxes by taking advantage of various deductions and tax credits. Means that you must tell the IRS what your tax liability is file a tax return Does not mean that the tax laws don’t apply to you THE COST OF TAXES TO TAXPAYERS: o the tax payment itself o Deadweight Losses (DWLs) of a tax Because taxes distort incentives = DWLs The reduction of taxpayer’s economic well-being by the amount of revenue raised by the government. o Administrative Burdens Complying w/ tax laws creates DWLs Taxpayers lose additional time & money documenting, computing, and avoiding taxes over and above the actual taxes they pay It is part of the inefficiency it creates o The Average Tax Rate = total taxes paid divided by total income o The Marginal Tax Rate = the extra taxes paid on an additional dollar of income o Lump-sum tax = is the same amount for every person regardless of earnings or any actions that the person might take. Considered efficient taxes because they do not influence a person’s decision on how much to work TAXES AND EQUITY o BENEFITS PRINCIPLE: The idea that people should pay taxes based on the benefits they receive from government services A Gasoline Tax: Tax revenues from a gasoline tax are used to finance our highway system People who drive the most also pay the most toward maintaining roads
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According to this principle, it is fair for people to pay taxes based on benefits they receive from the government. o ABILITY-TO-PAY PRINCIPLE: The idea that taxes should be levied on a person according to how well that person can shoulder the burden It leads to two corollary notions of equity According to this principle, it is fair for people to pay taxes on their capability to handle the financial burden. VERTICAL EQUITY: The idea that taxpayers w/ a greater ability to pay taxes should pay larger amounts (e.g. people w/ higher incomes should pay more than people w/ lower incomes) Alternative Tax Systems (w/in Vertical Equity) Regressive Tax : tax for which high-income taxpayers pay a smaller fraction of their income than do low-income taxpayers Progressive Tax : a tax for which high-income taxpayers pay a larger fraction of their income than do low-income taxpayers Proportional Tax: a tax for which high-income taxpayers and low- income taxpayers pay the same fraction of income HORIZONTAL EQUITY: the idea that taxpayers w/ similar abilities to
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This note was uploaded on 02/06/2012 for the course ECON 1015 taught by Professor Myounglee during the Spring '08 term at Missouri (Mizzou).

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ECON FINAL STUDY GUIDE - THE DESIGN OF THE TAX SYSTEM Two...

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