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TAXES: Efficiency and Equity – remote instructionsStep 1: Read Module 50 in the textbook. Some of this Module is reviewing previous units, but it highlights content related to this note sheet. Step 2: Read through and fill out notes provided below. Additional teacher points following along note sheet:The first part of this note sheet is reviewing content we learned from Unit 2B and Unit 4F. The models below help visually understand the specific notes to the first question. The Laffer curve was/is used to support a lower marginal tax rate. A significant decrease in top rates came under the Reagan Administration In the United States, we have a progressive tax system with multiple tax rates depending on your income. The 2020 marginal tax rates are below. Keep in mind that the marginal rates increase, but only the additional income is taxed at the higher rates making the average tax rate increase below marginal rates. Simplicity is always a goal to improve our tax system, not sure that we accomplished that with the new Tax Cut and Jobs Act of 2017. The main reason is that the marginal/average tax rates are different than the effective rate. The overall tax rate for the 400 wealthiest households in the US including federal, state and local taxes – last year was 23%, lower than for any other income group for the first time on record. In 1950, the wealthiest Americans paid 70% of their income in taxes. Lump Sum tax is simple and efficient, but it is not equitable.The rest of the note sheet is term based. It will be important to review terms and examples. Much of this information is tested on the multiple choice section of the AP exam. I have provided a practice worksheet (What is a fair tax?) on quia for you to review the content.Step 3: Practice questions on quia and in your textbook to review what you have learned.TAXES: EFFICIENCY versus EQUITYHow do we determine tax incidence?How does the Laffer Curve justify lower marginal rates?Why should we use simplicity as criteria for a “Fair Tax”?Which type of tax is most efficient?How should the burden of taxes be divided among the population? How do we evaluate whether a tax system is fair?Benefits PrincipleAbility to Pay PrincipleTax StructuresThis chart shows how two taxpayers, Ron and Mary, would be affected by three types of tax structures.Type of TaxDescriptionExampleRon’s taxes on $50,000 incomeMary’s taxes on $150,000 incomeProportionalProgressiveRegressiveWhich of these systems is most fair?What about taxes on businesses (i.e. corporate tax)?In establishing a tax system, why should we consider Efficiency? How about Equity?TAXES: EFFICIENCY versus EQUITYHow do we determine tax incidence?Price elasticities of Supply and DemandElasticities also determine Deadweight LossConsiderable debate about amount of DWL with wage taxes (Figures 8.6, 8.9, 8.10)Labor ActivityConclusion: Increase taxes, DWL rises more quickly than the size of the tax and level of tax revenue (Figure 6)How does the Laffer Curve justify lower marginal rates?Show Figure 19.1 and Figure 5Figure 8.5 shows you the difference between marginal and average taxesAverage tax – total taxes/total incomeMarginal tax – extra taxes paid on an additional amount of incomeEffective tax – lower than average because of deductionsCheck out latest IRS tax brackets and ratesModern Debate: Should income or consumption be taxed? What would create the least amount of Deadweight Loss?Current income tax laws discourage savingsIf consumption is taxed, incentives will changeEurope relies more on consumptionWhy should we use simplicity as criteria for a “Fair Tax”?Taxes lead to DWL because they lower total surplus and create large administrative burden because of large amount of paperwork. (Hire financial planner and/or lawyer)Which type of tax is most efficient?Lump Sum Tax – same amount ($1,000) for every person. Marginal tax is zeroNo distortion of incentives, administrative burden, or loss of surplusThis tax is not a proportional tax (same %). It is a Regressive Tax, which leads to income inequalityHow should the burden of taxes be divided among the population? How do we evaluate whether a tax system is fair?Benefits Principle – people should pay taxes based on the benefits they receive from government services.Gas tax leads to maintenance of roadsGoal is to make public goods similar to private goodsAbility to Pay Principle – Taxes should be levied on a person based on how well they can shoulder the burdenVertical Equity – (High for rich, low for poor)Horizontal Equity – (Similar abilities pay the same)Tax StructuresThis chart shows how two taxpayers, Ron and Mary, would be affected by three types of tax structures.Type of TaxDescriptionExampleRon’s taxes on $50,000 incomeMary’s taxes on $150,000 incomeProportionalA constant % of income is taken in taxes as income increases“Flat” tax$7,500 or 15% of income$22,500 or 15% of incomeProgressiveA larger % of income is taken in taxes as income increasesIncome tax$5,000 or 10% of income$45,000 or 30% of incomeRegressiveA smaller % of income is taken in taxes as income increasesSales tax$2,000 or 5% of total purchases of $40,000; tax bill is 4% of income$3,000 or 5% of total purchases of $60,000; tax bill is 2% of incomeWhich of these systems is most fair?Proportional – everyone pays the same fraction of income (Herman Cain’s 999 plan)Horizontal Equity because no deductionsProgressive – high income pay larger fraction than lower income (Vertical Equity)Nominal versus Effective tax rate – deductions make it less progressiveRegressive – high income pay smaller fraction than lower incomeSales Tax – exemptions used to make less regressiveLump Sum – most efficient, but regressiveSocial Security – (Proportional up to a certain amount and then regressive)What about taxes on businesses (i.e. corporate tax)?Popular because a corporation is nonhuman and facelessBurden falls on stockholders, customers, workers, communities, suppliers, etc.Increase in taxes leads to increase cost of production. Firms cut production, which lowers supply and increase prices on customers. These increases could possibly lead to higher unemployment or a decrease in wages.In establishing a tax system, why should we consider Efficiency? How about Equity?Importance of Efficiency – DWL minimization and Surplus maximization. Remember the basic economic problem is SCARCITY.Importance of Equity – Our country was based on communal notions and idealsDiscussion question: Do policies that redistribute income hurt efficiency, or are there policies that can improve both equity and efficiency? ................
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