12The Design of the Tax System.docx

12The Design of the Tax System.docx

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12TheDesignoftheTaxSystem

THEDESIGNOF

THETAXSYSTEM

INTHISCHAPTERYOUWILL...

GetanoverviewofhowtheU.S.

governmentraisesandspendsmoney

Examinethe

efficiencycostsoftaxes

Learnalternativewaystojudgetheequityofatax

system

Al“Scarface”Capone,thenotorious1920sgangsterandcrimeboss,wasneverconvictedforhismanyviolentcrimes.Yeteventuallyhedidgotojail—fortaxeva-sion.HehadneglectedtoheedBenFranklin’sobservationthat“inthisworldnothingiscertain,butdeathandtaxes.”

WhenFranklinmadethisclaimin1789,theaverageAmericanpaidlessthan

5percentofhisincomeintaxes,andthatremainedtrueforthenexthundred

years.Overthecourseofthetwentiethcentury,however,taxeshavebecomeever

moreimportantinthelifeofthetypicalperson.Today,alltaxestakentogether—

includingpersonalincometaxes,corporateincometaxes,payrolltaxes,salestaxes,

andpropertytaxes—useupaboutathirdoftheaverageAmerican’sincome.In

manyEuropeancountries,thetaxbiteisevenlarger.

Taxesareinevitablebecauseweascitizensexpectthegovernmenttoprovide

uswithvariousgoodsandservices.Theprevioustwochaptershavestartedto

Seewhystudyingtaxincidenceiscrucialfor

evaluatingtaxequity

Considerthe

tradeoffbetweenefficiencyand

equityinthedesignofataxsystem

243

shedlightononeoftheTenPrinciplesofEconomicsfromChapter1:

Thegovern-mentcansometimesimprovemarketoutcomes.Whenthegovernmentremediesanexternality（suchasairpollution）,providesapublicgood（suchasnationalde-fense）,orregulatestheuseofacommonresource（suchasfishinapubliclake）,itcanraiseeconomicwell-being.Yetthebenefitsofgovernmentcomewithcosts.Forthegovernmenttoperformtheseanditsmanyotherfunctions,itneedstoraiserevenuethroughtaxation.

Webeganourstudyoftaxationinearlierchapters,wherewesawhowataxonagoodaffectssupplyanddemandforthatgood.InChapter6wesawthatataxre-ducesthequantitysoldinamarket,andweexaminedhowtheburdenofataxissharedbybuyersandsellers,dependingontheelasticitiesofsupplyanddemand.InChapter8weexaminedhowtaxesaffecteconomicwell-being.Welearnedthattaxescausedeadweightlosses:

Thereductioninconsumerandproducersurplusre-sultingfromataxexceedstherevenueraisedbythegovernment.

Inthischapterwebuildontheselessonstodiscussthedesignofataxsystem.WebeginwithafinancialoverviewoftheU.S.government.Whenthinkingaboutthetaxsystem,itisusefultoknowsomebasicfactsabouthowtheU.S.govern-mentraisesandspendsmoney.Wethenconsiderthefundamentalprinciplesoftaxation.Mostpeopleagreethattaxesshouldimposeassmallacostonsocietyaspossibleandthattheburdenoftaxesshouldbedistributedfairly.Thatis,thetaxsystemshouldbebothefficientandequitable.Aswewillsee,however,statingthesegoalsiseasierthanachievingthem.

AFINANCIALOVERVIEWOFTHEU.S.GOVERNMENT

Howmuchofthenation’sincomedoesthegovernmenttakeastaxes?

Figure12-1showsgovernmentrevenue,includingfederal,state,andlocalgovernments,asapercentageoftotalincomefortheU.S.economy.Itshowsthat,overtime,thegov-ernmenthastakenalargerandlargershareoftotalincome.In1902,thegovern-mentcollected7percentoftotalincome;in1998,itcollected32percent.Inotherwords,astheeconomy’sincomehasgrown,thegovernmenthasgrownevenmore.

Table12-1comparesthetaxburdenforseveralmajorcountries,asmeasuredbythecentralgovernment’staxrevenueasapercentageofthenation’stotalin-come.TheUnitedStatesisinthemiddleofthepack.TheU.S.taxburdenislowcomparedtomanyEuropeancountries,butitishighcomparedtomanyotherna-tionsaroundtheworld.Poorcountries,suchasIndiaandPakistan,usuallyhaverelativelylowtaxburdens.ThisfactisconsistentwiththeevidenceinFigure12-1ofagrowingtaxburdenovertime:

Asanationgetsricher,thegovernmenttypi-callytakesalargershareofincomeintaxes.

Theoverallsizeofgovernmenttellsonlypartofthestory.Behindthetotaldol-larfiguresliethousandsofindividualdecisionsabouttaxesandspending.Toun-derstandthegovernment’sfinancesmorefully,let’slookathowthetotalbreaksdownintosomebroadcategories.

Revenueas

Percentof35

GDP

30Totalgovernment

25

Stateandlocal

20

15

Federal

10

5

0

1902

1913

192219271932

1940

19501960

1970198019901998

GOVERNMENTREVENUEASAPERCENTAGEOFGDP.Thisfigureshowsrevenueofthefederalgovernmentandofstateandlocalgovernmentsasapercentageofgrossdomesticproduct（GDP）,whichmeasurestotalincomeintheeconomy.ItshowsthatthegovernmentplaysalargeroleintheU.S.economyandthatitsrolehasgrownovertime.

SOURCE:

HistoricalStatisticsoftheUnitedStates;EconomicReportofthePresident1999;andauthor’scalculations.

Figure12-1

France38.8%UnitedKingdom33.7

Germany29.4

Table12-1

CENTRALGOVERNMENTTAX

REVENUEASAPERCENTOFGDP

Brazil

19.7

UnitedStates

19.3

Canada

18.5

Russia

17.4

Pakistan

15.3

Indonesia

14.7

Mexico

12.8

India

10.3

SOURCE:

WorldDevelopmentReport1998/99.

THEFEDERALGOVERNMENT

TheU.S.federalgovernmentcollectsabouttwo-thirdsofthetaxesinoureconomy.Itraisesthismoneyinanumberofways,anditfindsevenmorewaystospendit.

TAX

AMOUNT

（INBILLIONS）

AMOUNTPERPERSON

PERCENTOFRECEIPTS

Individualincometaxes

$869

$3,194

48%

Socialinsurancetaxes

609

2,239

34

Corporateincometaxes

182

669

10

Other

146

537

8

ReceiptsTable12-2showsthereceiptsofthefederalgovernmentin1999.To-talreceiptsinthisyearwere$1,806billion,anumbersolargethatitishardtocom-prehend.Tobringthisastronomicalnumberdowntoearth,wecandivideitbythesizeoftheU.S.population,whichwasabout272millionin1999.WethenfindthattheaverageAmericanpaid$6,639tothefederalgovernment.Atypicalfamilyoffourpaid$26,556.

Thelargestsourceofrevenueforthefederalgovernmentistheindividualin-cometax.AsApril15approaches,almosteveryAmericanfamilyfillsoutataxformtodeterminehowmuchincometaxitowesthegovernment.Eachfamilyisrequiredtoreportitsincomefromallsources:

wagesfromworking,interestonsavings,dividendsfromcorporationsinwhichitownsshares,profitsfromanysmallbusinessesitoperates,andsoon.Thefamily’staxliability（howmuchitowes）isthenbasedonitstotalincome.

Afamily’sincometaxliabilityisnotsimplyproportionaltoitsincome.In-stead,thelawrequiresamorecomplicatedcalculation.Taxableincomeiscom-putedastotalincomeminusanamountbasedonthenumberofdependents（primarilychildren）andminuscertainexpensesthatpolicymakershavedeemed“deductible”（suchasmortgageinterestpaymentsandcharitablegiving）.ThenthetaxliabilityiscalculatedfromtaxableincomeusingthescheduleshowninTable12-3.Thistablepresentsthemarginaltaxrate—thetaxrateappliedtoeachad-ditionaldollarofincome.Becausethemarginaltaxraterisesasincomerises,higher-incomefamiliespayalargerpercentageoftheirincomeintaxes.（Wedis-cusstheconceptofmarginaltaxratemorefullylaterinthischapter.）

Almostasimportanttothefederalgovernmentastheindividualincometaxarepayrolltaxes.Apayrolltaxisataxonthewagesthatafirmpaysitsworkers.Table12-2callsthisrevenuesocialinsurancetaxesbecausetherevenuefromthesetaxesisearmarkedtopayforSocialSecurityandMedicare.SocialSecurityisanin-comesupportprogram,designedprimarilytomaintainthelivingstandardsoftheelderly.Medicareisthegovernmenthealthprogramfortheelderly.Table12-2showsthattheaverageAmericanpaid$2,239insocialinsurancetaxesin1999.

Table12-2

RECEIPTSOFTHEFEDERAL

GOVERNMENT:

1999

Total$1,806$6,639100%

SOURCE:

EconomicReportofthePresident,1999,tableB-80.

ONTAXABLEINCOME...THETAXRATEIS...

Upto$25,75015.0%From$25,750to$62,45028.0

From$62,450to$130,25031.0

From$130,250to$283,15036.0

Over$283,15039.6

Nextinmagnitude,butmuchsmallerthaneitherindividualincometaxesorsocialinsurancetaxes,isthecorporateincometax.Acorporationisabusinessthatissetupasaseparatelegalentity.Thegovernmenttaxeseachcorporationbasedonitsprofit—theamountthecorporationreceivesforthegoodsorservicesitsellsminusthecostsofproducingthosegoodsorservices.Noticethatcorporateprof-itsare,inessence,taxedtwice.Theyaretaxedoncebythecorporateincometaxwhenthecorporationearnstheprofits;theyaretaxedasecondtimebytheindi-vidualincometaxwhenthecorporationusesitsprofitstopaydividendstoitsshareholders.

Thelastcategory,labeled“other”inTable12-2,makesup8percentofreceipts.Thiscategoryincludesexcisetaxes,whicharetaxesonspecificgoodslikegasoline,cigarettes,andalcoholicbeverages.Italsoincludesvarioussmallitems,suchases-tatetaxesandcustomsduties.

SpendingTable12-4showsthespendingofthefederalgovernmentin1999.Totalspendingwas$1,727billion,or$6,350perperson.Thistablealsoshowshowthefederalgovernment’sspendingwasdividedamongmajorcategories.

ThelargestcategoryinTable12-4isSocialSecurity,whichrepresentsmostlytransferpaymentstotheel