ECON 510 Tax Policy PowerPoint Material 2015 J.

ECON 510 Tax Policy PowerPoint Material 2015 J.

ECON 510 Tax Policy PowerPoint Material 2015 J. Fred Giertz Institute of Government and Public Affairs and Department of Economics University of Illinois at Urbana Short On-Line Lectures Circular Flow (Khan Academy): https://www.khanacademy.org/economics-finance-domain/macroeconomics/gdp-topic/circularecon-gdp-tutorial/v/circular-flow-of-income-and-expenditures Supply and Demand (Khan Academy): https://www.khanacademy.org/economics-finance-domain/microeconomics/supply-demand-eq uilibrium Consumer and Producer Surplus (Khan Academy) https://www.khanacademy.org/economics-finance-domain/microeconomics/consumer-producer -surplus/consumer-producer-surplus-tut Role of the Market Decentralized system can lead to desirable

results Economic efficiency Maximizing net benefits Consumer and producer surpluses Economic equilibrium Coincidence of equilibrium and efficiency Examples of inefficiency Equity Evaluation of Market Efficiency Equity (fairness) Review of Economic Efficiency and Market Equilibrium REVIEW Marginal Cost

Marginal Marginal Benefit Examples of Inefficiency Price Ceiling http://www.economicshelp.org/microessays/markets/monopolydiagram/ Possible Problems with Market (What is the role government in a private enterprise economy?) Philosophical issues Technical issues Public goods Externalities Incomplete Markets Imperfect informationAsymmetric information Distribution Monopoly Macro issuesstability and growth Public Goods in More Detail Definitioncontrast with private goods Non-exclusion

Non-rivalry Public goods vs. public production vs. public provision Why does the market fail? Free riding problems Non-exclusion Insignificance Efficiency with public goods Externalities in More Detail Externalities defined Negative such as pollution Positive such as education Why do they create problems for the market? Social costs vs. private costs Corrective actions Are they needed? What form should they take? Externalities in More Detail Externalities defined

Negative such as pollution Positive such as education Why do they create problems for the market? Social costs vs. private costs Private costs + external costs= social costs Private benefits + external benefits= social benefits Example of inefficiencies Externalities (continued) Corrective actions Are they needed? (Pigou vs. Coase) What form should they take? Regulations Taxes and subsidies A market for externalities Firm A Level 0

1 2 3 4 5 6 7 MB for A 60 50 40 30 20 10 0 Reduce total from 12 to 6 Firm B Level 0 1 2 3

4 5 6 7 MB for B 22 18 14 10 6 2 0 Introduction to Taxation Taxes are one way of financing government along with borrowing, fees & charges, etc. Basic criteria for evaluating taxation Efficiency Neutrality as a goal Do as little harm to the functioning of the private market Equity or fairness

Equity Equity is basically a normative or ethical concept Equity like beauty is in the eye of the beholder Components of equity Horizontal equityequal treatment of equals Vertical equitythe appropriate differential treatment of unequal Taxes vs. Fees Fees are related to prices for public services where exclusion is possible. Generally, the revenue generated by a fee is used to finance the activity. Fees are applications of the benefitsreceived theory In practice, the distinction is often not well defined. Benefits-received vs. Ability-to-pay Benefits-received Advantages Mirrors private market? Provides incentives for citizens

Disadvantages Difficult to apply in some cases Not useful for redistribution Ability-to-payadvantages and disadvantages Letter to Editor Champaign News-Gazette May 17, 2010 Inclusive vs. Exclusive Rate Exclusive vs. Inclusive Rates Rates with equal revenue 0.0% 5.0% 10.0% 15.0% 20.0% 25.0% 30.0% 35.0%

40.0% 45.0% 50.0% 55.0% 60.0% 65.0% 70.0% 75.0% 80.0% 85.0% 90.0% 95.0% 99.0% 0.0% 5.3% 11.1% 17.6% 25.0% 33.3% 42.9% 53.8% 66.7% 81.8% 100.0%

122.2% 150.0% 185.7% 233.3% 300.0% 400.0% 566.7% 900.0% 1900.0% 9900.0% 1.4 Ratio 1.2 1.05 1.11 1.18 1.25 1.33 1.43 1.54 1.67

1.82 2.00 2.22 2.50 2.86 3.33 4.00 5.00 6.67 10.00 20.00 100.00 1 Exclusive Rate Inclusive Exclusive Tax Tax Rate Rate Equal Yield: Inclusive and Exclusive rates

0.8 0.6 0.4 0.2 0 0 0.1 0.2 0.3 Inclusive Rate Ti = (Te)/(1+Te) 0.4 0.5 0.6 Rationales for Progressivity Example

Income 0 10 20 30 40 50 60 70 80 90 100 110 120 130 140 150 160 170 180 190 200 Total Utility

Marginal Utility Results Taxes Tax Rates Utility $50 person$200 person $50 person$200 person $50 person$200 person Compare 100 195 285 370 450 525 595 660 720 775 825 870 910

945 975 1000 1020 1035 1045 1050 100 95 90 85 80 75 70 65 60 55 50 45 40 35 30 25 20

15 10 5 Taxes needed = $40 Equal $ Proportional $ 16% Minimum sacrifice Equal Sacrifice Proportional Sacrifice $20 $8 $20 $32 40.0% 16.0% 10.0% 16.0% 165 U 64 U

15 U 34 U $0 $5 $2.41 $40 $35 $37.575 0.0% 10.0% 4.8% 20.0% 17.5% 18.8% 0U 40U 45.15U 50 U

40U 19.35U What are the problems with this approach? Is utility measurable? Does MU decline? Can you compare utility among persons? 5+10+1 Measuring Progressivity Flat Rate Lump Sum Income 0 10000 20000 30000 40000 50000 60000 70000

80000 90000 100000 Average Rate Tax 1000 1000 1000 1000 1000 1000 1000 1000 1000 1000 1000 10.00% 5.00% 3.33% 2.50% 2.00%

1.67% 1.43% 1.25% 1.11% 1.00% Income Consump. 0 3000 10000 11000 20000 19000 30000 27000 40000 35000 50000 43000 60000 51000 70000 59000 80000 67000

90000 75000 100000 83000 Tax 300 1100 1900 2700 3500 4300 5100 5900 6700 7500 8300 Income Tax Income 0 0 10000 1000

20000 2000 30000 3000 40000 4000 50000 5000 60000 6000 70000 7000 80000 8000 90000 9000 100000 10000 10% Tax AR ERR 11.00% 9.50% 9.00%

8.75% 8.60% 8.50% 8.43% 8.38% 8.33% 8.30% Tax = 10% of consumption Consumption= 3000+.8*Income Income Income 0 10000 20000 30000 40000 50000 60000 70000 80000 90000 100000

Average Rate ERR 10.00% 10.00% 10.00% 10.00% 10.00% 10.00% 10.00% 10.00% 10.00% 10.00% Tax 0 1000 2500 4500 6500 9000 11500 14000 16500 19000

21500 Flat Rate with 10,000 Exempt Income Tax 0 0 10000 0 20000 1000 30000 2000 40000 3000 50000 4000 60000 5000 70000 6000 80000 7000 90000

8000 100000 9000 10% Tax AR 10.00% 12.50% 15.00% 16.25% 18.00% 19.17% 20.00% 20.63% 21.11% 21.50% Tax Brackets 0-10,000 0-10,000 10% 10-20,000 10-20,000 1,000+15% 20-40,000 2,500+20% > 40,000

6,500+25%-------------------------------------- Average Rate ERR 0.00% 5.00% 6.67% 7.50% 8.00% 8.33% 8.57% 8.75% 8.89% 9.00% I Gini Coefficient = A/(A+B) G=0; Complete Equality G=1; Complete Inequality Tax Avoidance, Evasion and Deliquency Economics of crime Benefits

Costs Direct costs Probability of arrest and conviction Severity of punishment Economics of evasion Benefitstaxes saved Costs Direct costs Psychic costs Probability of detection Severity of punishment Tax Rates and Tax Revenues Visualizing the Laffer Curve Laffer CurveTax rates and Tax Revenues

Are tax revenues proportional to tax rates? The example of a tariff? Elasticity issues Cigarettes? A tax on Cokes vs. a tax on soft drinks? The Laffer curve Dynamic scoring Short run Long run Adjustmentsexample of income tax Tax Expenditures Tax expenditures are revenue losses attributable to tax provisions that often result from the use of the tax system to promote social goals without incurring direct expenditures. How tax expenditures are structured affects both who will benefit from them and how much they will reduce federal revenues. Partial equilibrium approach The excise tax example Selective excise

Specific (unit) vs. ad valorem Is the tax applied on the consumer or the producer? Different approaches Same results Excise tax incidence--examples Basic examplesharing the price burden Consumer and producer price burden Equivalence of consumer and producer imposition Short run and long run Special cases Inelastic supply Inelastic demand Elastic supply Tax Legal Responsibility of Seller Tax Legal Responsibility of Buyer Taxation and efficiency Review of efficiency concept

Welfare cost and excess burden The excise example once againBasic case Tax revenues Welfare cost s Special cases Inelastic supply Inelastic demand Tax rates and tax revenues Are tax revenues proportional to tax rates? The example of a tariff? Elasticity issues Cigarettes? A tax on Cokes vs. a tax on soft drinks? The Laffer curve Dynamic scoring Short run Long run Adjustmentsexample of income tax Individual Income Taxation Definition of income

Measure of ability-to-pay Haig-Simons, Accretion concept, Comprehensive Income, Economic income Income may be defined as the algebraic sum of the market value of rights exercised in consumption plus the change in value of the store of property rights between the beginning and end of the period in question. Simons Income = Consumption + Change in Wealth Calculation of Income I C NW0 100 100 50 110 100 40 90 100 60 NW1

50 50 50 Individual Income Taxation (continued) Other definitions Legal (AGI) Income as production Income vs. consumption (a first look) Income = Consumption + Saving Income Consumption = Saving The issue is the tax treatment of savings Applications of the Haig-Simons Definition Wages H-S income The corporate income (Disc. Later) Retained earnings (Discussed later) Employee-paid safety equipment Excludable H-S income

Social Security payments H-S income Death transfers H-S income Gifts H-S income Employer-paid education (Depends on purpose) Unemployment Compensation H-S income Housingowning vs. renting Net imputed rent H-S income Bequests H-S income to heirs Employer-paid vacation H-S income Interest H-S income (real return only) Owning vs. leasing a car Employer-paid insurance H-S income Travel expenses for sales person

Excludable H-S income Dividends H-S income (real return only) Inflationary wage increases H-S income (with indexation) Capital gains H-S income (real return only) Employer-paid pension contributions H-S income (real return only) Education expensesnot employer paid (Depends on purpose) Child care ???? Business class air travel for business purposes (Depends on purpose) Free checking accounts (tax Interest, charge for checking)

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