Business Conditions-Charles W. Upton

The Incidence of Taxes

The Incidence of Taxes

Whom Should We Tax?

• Two major questions– Incidence– Efficiency

The Incidence of Taxes

Incidence

• Who pays the cost of running the government

The Incidence of Taxes

An Example

• 1,000 people earn $150,000

• 9,000 people earn $10,000

• The top 10% earns 15 times as much as the lower 90%

• Government costs $10,000,000 to run

The Incidence of Taxes

An Example

• 1,000 people earn $150,000

• 9,000 people earn $10,000

• The top 10% earns 15 times as much as the lower 90%

• Government costs $10,000,000 to run

• Impose the entire tax burden on the top 1,000.

000,10$000,1

000,000,10$

The Incidence of Taxes

An Example

• 1,000 people earn $150,000

• 9,000 people earn $10,000

• The top 10% earns 15 times as much as the lower 90%

• Government costs $10,000,000 to run

• Impose the entire tax burden on the top 1,000.

• Their earnings drop to $140,000 and the ratio is 14:1.

The Incidence of Taxes

Going with the Flow

• 1,000 people earn $150,000

• 9,000 people earn $10,000

• The top 10% earns 15 times as much as the lower 90%

• Government costs $10,000,000 to run

• Tax the top 1,000 $100,000 each, & give everyone $9,000.

Taxpayers 1,000 Total Revenue $100,000,000

(=1,000 X $100,000 Gov’t Spending $10,000,000 Net $90,000,000 Per Capita $9,000

The Incidence of Taxes

An Example

• 1,000 people earn $150,000

• 9,000 people earn $10,000

• The top 10% earns 15 times as much as the lower 90%

• Government costs $10,000,000 to run

• The top 10% now earns

$150,000 - $100,000 + $9,000 = $59,000

• The bottom 90% now earns

$10,000 + $9,000 = $19,000

The Incidence of Taxes

An Example

• 1,000 people earn $150,000

• 9,000 people earn $10,000

• The top 10% earns 15 times as much as the lower 90%

• Government costs $10,000,000 to run

• The income ratio is 3:1

(Actually 59:19)

The Incidence of Taxes

Progressive Taxes

• A tax is progressive if the tax bill rises faster than your income.

• It is regressive if the tax bill rises slower than your income

• Income Tax = 20% with $10,000 exemption

The Incidence of Taxes

Progressive Taxes

• A tax is progressive if the tax bill rises faster than your income.

• It is regressive if the tax bill rises slower than your income

• Income Tax = 20% with $10,000 exemption

• $10,000 = $0• $20,000 = $2,000

(10%)• $100,000 = $18,000

(18%)

The Incidence of Taxes

The US Tax Code

• A tax is progressive if the tax bill rises faster than your income.

• It is regressive if the tax bill rises slower than your income

• First tax bracket is 10%.

• Next tax bracket is 15%

• Then 25% (eventually)

The Incidence of Taxes

The Sales Tax

• A tax is progressive if the tax bill rises faster than your income.

• It is regressive if the tax bill rises slower than your income

• Sales tax is generally thought to be regressive.

The Incidence of Taxes

Some Problems

• Is there a philosophical case for a progressive tax structure?

The Incidence of Taxes

Some Problems

• Is there a philosophical case for a progressive tax structure?

• Don’t tax you,don’t tax metax the man behind the tree!

The Incidence of Taxes

Some Problems

• Is there a philosophical case for a progressive tax structure?

• Don’t tax you,don’t tax metax the man behind the tree!

• Taxes have behavioral implications

The Incidence of Taxes

Some Problems

• Is there a philosophical case for a progressive tax structure?

• Don’t tax you,don’t tax metax the man behind the tree!

• Taxes have behavioral implications

• Consider the Hatfield “proposal” for a 100% tax on incomes above $200,000.

The Incidence of Taxes

Some Problems

• Is there a philosophical case for a progressive tax structure?

• Don’t tax you,don’t tax metax the man behind the tree!

• Taxes have behavioral implications

• Consider the Hatfield “proposal” for a 100% tax on incomes above $200,000.

The Incidence of Taxes

Yet another problem

The Tradeoff between Progressive Taxation and

economic efficiency

Flatland has total income of $100,000,000. It must finance a

government budget of $20,000,000

The Incidence of Taxes

Yet another problem

The Tradeoff between Progressive Taxation and

economic efficiency

Flatland has total income of $100,000,000. It must finance a

government budget of $20,000,000

The first $X of income will be exempt, and the rest will be taxed at a constant rate

The Incidence of Taxes

Yet another problem

Flatland has total income of $100,000,000. It must finance a

government budget of $20,000,000

To exempt the following amount

of income

Its tax rate must be

$20,000,000 25%

$30,000,000 28%

$40,000,000 33%

$50,000,000 50%

%25000,000,20$000,000,100$

000,000,20$

The Incidence of Taxes

Yet another problem

Flatland has total income of $100,000,000. It must finance a

government budget of $20,000,000

To exempt the following amount

of income

Its tax rate must be

$20,000,000 25%

$30,000,000 28%

$40,000,000 33%

$50,000,000 40%

The higher the exemption (the greater the progression) the higher the marginal rate.

The Incidence of Taxes

Consumption and Incomeover the Life Cycle

The Incidence of Taxes

Consumption and Incomeover the Life Cycle

Some of the difference in income relates to where we are in the life cycle

The Incidence of Taxes

Consumption and Incomeover the Life Cycle

Pension plans switch income from high tax years to low tax years.

The Incidence of Taxes

Consumption and Incomeover the Life Cycle

The Incidence of Taxes

Consumption and Incomeover the Life Cycle

When John Smith, MD is working, he makes more than Joe College, BA, but then he spend years in Med School and years in residency.

The Incidence of Taxes

Consumption and Incomeover the Life Cycle

Is it fair to take a higher percentage of Dr. Smith’s income than Joe College?

The Incidence of Taxes

Consumption and Incomeover the Life Cycle

Indeed, what about the comparison between Joe College and Hank High School Grad?

The Incidence of Taxes

Another Query

• Who has the higher marginal tax rate, a typical college professor or Bill Gates?

• Probably Bill Gates, who pays capital gains rates of 20% on most of his “income”.

The Incidence of Taxes

Payments in Kind

• There are other means of avoiding income taxes by taking your income in kind (perks).

• The CEO gets a fancy apartment in Manhattan, a country club membership, etc.

The Incidence of Taxes

End

©2003 Charles W. Upton. All rights reserved