Foldvary, Econ 12.

Chapter 12, Design of the Tax System.

P. 243: Total of taxes take 1/3 of average income.

This understates it, since it does not include the costs of complying with regulation.

That's about $6000 per year for an average family.

So for an income of $30,000, $10 is p aid in taxes, and $6000 is foregone income for regulation.

Average income could double if not for taxes and regulations.

Poor countries collect a lower percentage of national income in taxes, but have more restrictive and more costly regulations, so the total government burden is higher in, say, India.

The "marginal tax rate" of an income tax is the tax paid per extra dollar of income.

In the graduated tax system the US has, a person has a higher marginal tax rate with higher income

The most important effect on enterprise and labor depends on the marginal rate (p. 254).


The tax paid for Social Security is 15 percent of income. It is also called a payroll tax, because it is only on employee and self-employment wages and not on income from interest or rent.

There are two income tax systems in the US, one for natural persons and one for corporations.

A corporation has the status of a legal person.

Corporate profits are subject to double taxation, once as corporate income, and again as personal income from dividends.

California also has a personal and corporate income tax.

An excise tax is an indirect tax, either passed on to someone other than the agent that pays the tax, or else on an activity or privilege rather than directly on property or income.

California has a state sales tax, with local taxes added to it. Total over 8 percent.

Tariffs are excise taxes, and there are federal excise taxes on gasoline, airline tickets, and other goods. The corporate income tax is an excise tax on the privilege of operating as a corporation.

The personal income tax is an excise tax on the activity of obtaining income, the tax measured by the amount of income.

Property taxes, mostly on real estate. Collected by States and local governments.

User fees. Tolls, bus and postage. Parking meters.

Government spending.

Transfer payments redistribute income among groups.

Social security redistributes from workers to retired folks and disabled former workers.

Other examples: medicare, various welfare programs, unemployment, subsidies, grants.

Goods and services.

Military. Amount is understated because of implicit opportunity costs, such as land used.

Education. Postal. Courts. Parks and forests. Enforcing regulations. Space. War on drugs.

Highways and streets. Local: police, libraries, garbage, fire.

Interest on the government debt.

For past government spending.

Borrowing is economically efficient if for productive investments.

Borrowing for current consumption decreases future consumption.

So we are consuming less by paying taxes for interest paid for past consumption.

Federal government had a surplus in late 1990s, but now is heading back to a deficit.

Usually there is a deficit during war time, as we are now.

Three objectives in a tax system:

1. Revenue. 2. Equalization. 3. Forcing behavior.

3 by taxing e.g. tobacco and alcohol, or by tax reductions: credits and deductions such as for municipal bonds, or for providing low-income housing.

Criteria: efficiency and equity.

There is a high excess burden and administrative cost from both income and sales taxes.

Taxes on wages lead to less overtime work, earlier retirement, fewer people working, less self-employment, and less investment. There is lower income and less growth.

Some of the high administrative costs comes from the complexity of the income taxes, which is often a deliberate policy of giving tax breaks to special interests.

Mankiw, p. 253: The administrative burden is 10 times greater for small business.

$390 spend for every $100 in corporate income taxes sent to Washington DC.

That implies less revenue from which to pay wages, and higher costs for products.

Income taxes also tax interest and dividends, which reduces savings.

Sales or consumption taxes also tax borrowing and results in higher interest payments, reducing borrowing.

Lump-sum taxes and subsidies.

A fixed amount of tax or subsidy, independent of income, output, or any other activity.

Can be a lump-sum per year.

A lump-sum tax has a zero marginal tax rate and no excess burden.

A tax on land rent has the same effect as a lump-sum tax, because there is a zero marginal tax on any additional exertion of labor or investment.

A lump-sum tax on persons may be seen to be unfair, because spending does not have equal benefits, and because the burden is greater on those with families or who wish to engage in leisure. For those whose income comes from wages, a lump-sum tax constitutes forced labor.

Such a tax was used by the European colonial powers in Africa to force natives to work for money, since the tax had to paid in cash.

In contrast, a tax on land does not impact labor, and is proportional to the benefit received by landowners when the spending is capitalized into higher rent income.

Taxes and equity (p. 254).

Two fairness criteria.

1. The benefits principle.

Payments to government are in exchange for benefits received.

User fees work that way. Payment for a passport.

But it's stretching it to say that the rich benefit more from welfare programs than the poor.

The true benefit principle is for direct, actual benefits received.

2. The ability to pay. Or, more cynically, the ability of government to extract.

Those with more wealth and income pay more.

But in practice, a lot of wealth and income is not taxed.

The US income and sales tax systems tax selected explicit flows of income, leaving untaxed large amounts of wealth and providing many explicit and implicit sources of income.

Those with the least political clout end up paying the most.

Also, on what moral standard is "ability to pay" based?

Thieves base their stealing on ability to pay and lack of defense, but is that just?

The marriage tax - p. 258.

Tax incidence: the ultimate burden of taxation, regardless of who pays it.

Some taxes have an excess benefit:

1) taxes on pollution reduce pollution and enhance the market.

2) taxes on auto congestion reduce congestion and increase efficiency.

3) taxes on land rent induce a more efficient use of land, raising wages and profit, with no excess burden.

Thus, the best tax system would be one with no excess burdens and with excess benefits.

Taxing rent can be said to also be equitable, because there is no burden on new owners, and because it conforms to the benefit principle, and equitably avoids subsidizing the landowners.