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Chapter Introduction 2

Chapter Objectives. Section 1: The Economics of Taxation. Explain the economic impact of taxes. . List three criteria for effective taxes.  Understand the two primary principles of taxation.  Understand how taxes are classified.

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Chapter Introduction 2

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  1. Chapter Objectives Section 1: The Economics of Taxation • Explain the economic impact of taxes.  • List three criteria for effective taxes.  • Understand the two primary principles of taxation.  • Understand how taxes are classified. Click the mouse button or press the Space Bar to display the information. Chapter Introduction 2

  2. Chapter Objectives Section 2: The Federal Tax System • Explain the progressive nature of the individual income tax.  • Describe the importance of the corporate tax structure.  • Identify other major sources of federal revenue. Click the mouse button or press the Space Bar to display the information. Chapter Introduction 3

  3. Chapter Objectives Section 3: State and Local Tax Systems • Explain how state governments collect taxes and other revenues.  • Differentiate between state and local revenue systems.  • Interpret paycheck deductions. Click the mouse button or press the Space Bar to display the information. Chapter Introduction 4

  4. Chapter Objectives Section 4: Current Tax Issues • Describe the major tax reforms since 1980.  • Debate the advantages and disadvantages of the value-added tax.  • Explain the features of a flat tax.  • Discuss why future tax reforms will occur. Click the mouse button or press the Space Bar to display the information. Chapter Introduction 5

  5. Click the mouse button to return to the Contents slide. End of Chapter Introduction

  6. Study Guide Main Idea Taxes are the single most important way of raising revenue for the government.  Reading Strategy Graphic Organizer As you read the section, complete a graphic organizer similar to the one on page 223 of your textbook by listing the criteria for taxes to be effective. Then, define each of the criteria in your own words. Click the mouse button or press the Space Bar to display the information. Section 1 begins on page 223 of your textbook. Section 1-1

  7. Study Guide (cont.) Key Terms • sin tax  • tax loophole  • individual income tax  • sales tax  • progressive tax  Click the mouse button or press the Space Bar to display the information. Section 1 begins on page 223 of your textbook. Section 1-2

  8. Introduction Why are we taxed? • An enormous amount of money is required to run the federal, state, and local governments of the United States. Click the mouse button or press the Space Bar to display the information. Section 1-4

  9. Figure 9.1 Introduction (cont.) Click the mouse button or press the Space Bar to display the information. Section 1-5

  10. Resource Allocation • The factors of production are affected whenever a tax is levied.  If taxes are placed on business, what happens to production? • A tax placed on a good or service at the factory raises the cost of production, which shifts the supply curve to the left.  • If demand remains unchanged, what happens to the price of the procuct? • If demand remains unchanged, the equilibrium price of the product goes up.  • What, then happens to demand? • People react to the higher price in a predictable manner–they buy less. Click the mouse button or press the Space Bar to display the information. Section 1-7

  11. Behavior Adjustment • Often taxes are used to encourage or discourage certain types of activities.  • The so-called sin tax– a relatively high tax designed to raise revenue and reduce consumption of a socially undesirable product – is an example of how a tax can be used to change behavior. Click the mouse button or press the Space Bar to display the information. Section 1-8

  12. Criteria for Effective Taxes • Some taxes will always be needed, so we want to make them as effective as possible.  • To do so, taxes must meet criteria: they must be equitable, simple, and efficient. Click the mouse button or press the Space Bar to display the information. Section 1-13

  13. Equity • The first criterion is equity or fairness.  • There is no overriding guide that we can use to make taxes completely equitable.  • However, it does make sense to avoid tax loopholes– exceptions or oversights in the tax law that allow some people and businesses to avoid paying taxes.  • Taxes generally are viewed as being fairer if they have fewer exceptions, deductions, and exemptions. Click the mouse button or press the Space Bar to display the information. Section 1-14

  14. Simplicity • Tax laws should be written so that both the taxpayer and the tax collector can understand them.  • The individual income tax– the tax on people’s earnings – is a prime example of a complex tax.  • The hardest thing in the world to understand is the income tax. • Albert Einstein • A sales tax– a general tax levied on most consumer purchases – is much simpler. Click the mouse button or press the Space Bar to display the information. Section 1-15

  15. Types of Taxes • Three general types of taxes exist in the United States today - proportional, progressive, and regressive.  • Each type of tax is classified according to the way in which the tax burden changes as income changes.  • A progressive tax is a tax that imposes a higher percentage rate of taxation on persons with higher incomes.  Click the mouse button or press the Space Bar to display the information. Section 1-20

  16. Note: These tax rate schedules are provided for tax planning purposes. To compute your actual income tax, please see the 2006 instructions for Form 1040, 1040A, or 1040EZ as appropriate. Single Filing Status 10% on income between $0 and $7,550 15% on the income between $7,550 and $30,650; plus $755.00 25% on the income between $30,650 and $74,200; plus $4,220.00 28% on the income between $74,200 and $154,800; plus $15,107.50 33% on the income between $154,800 and $336,550; plus $37,675.50 35% on the income over $336,550; plus $97,653.00

  17. Types of Taxes (cont.) • Progressive taxes usually use a marginal tax rate, the tax rate that applies to the next dollar of taxable income, which increases as the amount of taxable income increases. • A proportional tax imposes the same percentage rate of taxation on everyone, regardless of income. Click the mouse button or press the Space Bar to display the information. Section 1-21

  18. Figure 9.3 Types of Taxes (cont.) • A regressive tax is a tax that imposes a higher percentage rate of taxation on low incomes than on high incomes.  Click the mouse button or press the Space Bar to display the information. Section 1-22

  19. Click the mouse button to return to the Contents slide. End of Section 1

  20. Study Guide (cont.) Key Terms • payroll withholding system  • corporate income tax  • excise tax  • luxury good  • estate tax  • gift tax  • customs duty  • user fee • Internal Revenue Service (IRS)  • tax return  • indexing  • FICA  • medicare  • payroll tax  Click the mouse button or press the Space Bar to display the information. Section 2 begins on page 231 of your textbook. Section 2-2

  21. Introduction • The federal government collects taxes from a number of sources.  • The most important sources of government revenue are individual income taxes, Social Security taxes, and corporate income taxes. Click the mouse button or press the Space Bar to display the information. Section 2-4

  22. Individual Income Taxes • In 1913 the Sixteenth Amendment to the United States Constitution was ratified, allowing Congress to levy an income tax.  • Since then, the federal government has relied heavily on the individual income tax–the tax on people’s earnings–to finance its operations.  • The federal government collected about 48 percent of its total revenue from taxes on people’s earnings. Click the mouse button or press the Space Bar to display the information. Section 2-5

  23. Figure 9.4 Individual Income Taxes (cont.) Section 2-6

  24. Payroll Deductions • In most cases, the individual income tax is paid over time through a payroll withholding system.  • This is a system that requires an employer to automatically deduct income taxes from an employee’s paycheck and send it directly to the government.  • The agency that receives the tax payment is the Internal Revenue Service (IRS),the branch of the U.S. Treasury Department in charge of collecting taxes. Click the mouse button or press the Space Bar to display the information. Section 2-7

  25. Payroll Deductions (cont.) • After the close of the tax year on December 31, and before April 15 of the following year, the employee files a taxreturn.  • This is an annual report to the IRS summarizing total income, deductions, and the taxes withheld by employers.  • People who are self-employed are required to send quarterly estimates of their taxes to the Internal Revenue Service.  • These individuals must also make a final settlement for the previous year sometime before April 15. Click the mouse button or press the Space Bar to display the information. Section 2-8

  26. Figure 9.5 A Progressive Income Tax • The individual income tax is a progressive tax.  • According to individual tax tables, single individuals paid 15% to 39.6% depending on income. Click the mouse button or press the Space Bar to display the information. Section 2-9

  27. Figure 9.6 A Progressive Income Tax (cont.) • When a tax is progressive, the average tax rate goes up when income goes up.  Click the mouse button or press the Space Bar to display the information. Section 2-10

  28. FICA • The second most important federal tax is FICA.  • FICA is the Federal Insurance Contributions Act tax levied on both employers and employees to pay for Social Security and medicare.  • Medicare is a federal health-care program available to all senior citizens, regardless of income. Click the mouse button or press the Space Bar to display the information. Section 2-12

  29. Social Security Taxes • In 2000 the Social Security component of FICA was 6.2 percent of wages and salaries up to $76,200.  • Because the Social Security tax is capped, it is proportional up to $76,200 and regressive thereafter. Click the mouse button or press the Space Bar to display the information. Section 2-14

  30. Figure 9.6 Social Security Taxes (cont.) Section 2-15

  31. Medicare • In 1965 Congress added medicare to the Social Security program.  • More than 30 million senior citizens participate in medicare.  • The basic plan pays a major share of an eligible person's total hospital bills.  • The medicare component of FICA is taxed at a flat rate of 1.45 percent with no income cap. Click the mouse button or press the Space Bar to display the information. Section 2-16

  32. Corporate Income Taxes • Corporations as well as individuals must pay income taxes.  • The third largest category of taxes the federal government collects is the corporate income tax– the tax a corporation pays on its profits.  • The corporation is taxed separately from individuals because the corporation is recognized as a separate legal entity.  • Several marginal tax brackets, which are slightly progressive, are placed on corporations. Click the mouse button or press the Space Bar to display the information. Section 2-17

  33. Other Federal Taxes • In addition to income, FICA, and corporate taxes, the federal government receives revenue in the form of excise taxes, estate and gift taxes, and customs duties. Section 2-18

  34. Excise Taxes • The excise tax– a tax on the manufacture or sale of selected items, such as gasoline and liquor – is the fourth largest source of federal government revenue.  • Some early targets of excise taxes were carriages, snuff, and liquor.  • In 1991 Congress expanded the excise tax to include certain luxury goods. Click the mouse button or press the Space Bar to display the information. Section 2-19

  35. Excise Taxes (cont.) • An economic product is called a luxury good (or service) if the demand for the good rises faster than income when income grows.  • At first, the 19 percent luxury tax was indexed to keep up with inflation and was applied to many goods.  • The tax was unpopular, however, so boats, aircraft, jewelry, and furs were dropped in 1993.  • Later, Congress decided to phase out the luxury tax by the year 2002. Click the mouse button or press the Space Bar to display the information. Section 2-20

  36. Estate and Gift Taxes • An estate taxis the tax the government levies on the transfer of property when a person dies.  • Estate taxes can range from 18 to 55 percent of the value of the estate.  • The gift tax is a tax on donations of money or wealth and is paid by the person who makes the gift.  • The estate tax and the gift tax are progressive taxes–the larger the estate or gift, the higher the tax rate. Click the mouse button or press the Space Bar to display the information. Section 2-21

  37. Customs Duties • A customs duty is a charge levied on goods brought in from other countries.  • The Constitution gives Congress the authority to levy customs duties.  • Congress, in turn, has given the president authority by executive order to raise or lower the existing tariff rates by as much as 50 percent.  • Many types of goods are covered, ranging from automobiles to silver ore. Click the mouse button or press the Space Bar to display the information. Section 2-22

  38. Miscellaneous Fees • Finally, about 1.9 percent of federal revenue is collected through various miscellaneous fees.  • Since the 1980s user fees– charges levied for the use of a good or service –have been suggested with increasing frequency.  • These fees include entrance charges you pay to visit national parks, as well as the fees ranchers pay when their animals graze on federal land. Click the mouse button or press the Space Bar to display the information. Section 2-23

  39. Click the mouse button to return to the Contents slide. End of Section 2

  40. Figure 9.7 Other Revenues (cont.) Section 3-10

  41. Figure 9.7 Local Government Revenue Sources • The major sources of local government revenue also include taxes and funds from state and federal governments.  Section 3-12

  42. Click the mouse button to return to the Contents slide. End of Section 3

  43. Introduction • The complexity of our tax code is not accidental: it is the result of adjustments and amendments by Congress to both influence and reward behavior. Section 4-4

  44. Tax Reform in the 1980s and 1990s • Tax reform has received considerable attention in recent years.  • This is due to more changes in the tax code, and more changes in direction, than at any time in our nation’s history. Click the mouse button or press the Space Bar to display the information. Section 4-5

  45. Tax Reform in 1981 • When Ronald Reagan was elected president in 1980, he believed that high taxes were the main stumbling block to economic growth.  • He proposed the Economic Recovery Tax Act of 1981, which substantially reduced taxes for individuals and businesses.  • Businesses also got tax relief in the form of accelerated depreciation–larger than normal depreciation charges–which allowed firms to reduce federal income tax payments. Click the mouse button or press the Space Bar to display the information. Section 4-6

  46. Tax Reform: 1986, 1993 • By the mid-1980s, the idea that the tax code favored the rich and powerful was gaining momentum.  • In 1986 Congress passed the most sweeping tax reform act since income taxes were enacted in 1913.  • It ended the traditionally progressive individual income tax structure by reducing the 16 marginal tax brackets to two brackets.  • A 5 percent surcharge–or additional tax above and beyond the base rate–was added to bring the top bracket to 31 percent. Click the mouse button or press the Space Bar to display the information. Section 4-8

  47. Tax Reform: 1986, 1993 (cont.) • The law also made it difficult for the very rich to avoid taxes altogether.  • The alternative minimum tax–the personal income rate that applies whenever the amount of taxes paid falls below some designated level–was strengthened.  • The reform act also shifted about $120 billion of taxes from individuals to corporations over a five-year period. Click the mouse button or press the Space Bar to display the information. Section 4-9

  48. Tax Reform: 1986, 1993 (cont.) • The Omnibus Budget Reconciliation Act of 1993 was driven more by the need for the government to balance its budget than to overhaul the tax brackets.  • As a result, the law added the two top marginal tax brackets of 36 and 39.6 percent. Click the mouse button or press the Space Bar to display the information. Section 4-10

  49. Tax Reform in 1997 • In 1997 the largest tax reduction since the 1981 act was passed.  • On the economic side, the government found itself with unexpectedly high tax revenues in 1997.  • On the political side, the balance of power had dramatically shifted in the 1996 elections.  • The tax on capital gains– profits from the sale of an asset held for 12 months – was reduced from 28 to 20 percent. Click the mouse button or press the Space Bar to display the information. Section 4-11

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