Public Finance, Foldvary
Anderson, 2nd ed., Chapter 10
The Structure of Taxes
“We want a tax system that taxes on the basis of ability to pay.”
(What do you mean, “we”?)
Some argue for the benefits principle.
Also says we want a tax system that minimizes economic distortions.
But politicians don’t seem to care.
P. 291: government receipts. Includes borrowing.
The tax base
The tax base is the type and size of the source of a tax.
The source can be wealth such as real estate, a privilege such as a corporate charter, income, spending, value added, or personhood.
The size of the tax base depends on the total value of the source, and on exemptions.
For example, the property tax based is reduced when nonprofit organizations are exempt.
About eight percent of real-estate value is exempt from property taxes, mainly government-
owned property, schools, and churches.
The exemptions are an implicit subsidy.
Tax credits and deductions reduce the income tax base.
Not taxing unrealized gains also reduces the income tax base.
Most interest from municipal bonds is exempt.
The sales tax base in California is goods, with services exempt.
Basic foods are exempt, but not restaurant food.
Tax revenue equals tax base times rate.
Factor taxes and product taxes.
A tax based on the value of a good is called “ad valorem”.
If it is based on the quantity, it is a “unit tax.” For example, per gallon of gasoline.
There are two federal personal income taxes: the 1040 tax, and social security.
The 1040 income tax base: income minus exemptions, deductions, credits
The U.S. income tax is based on explicit flows of income.
It taxes nominal rather than real income: nominal interest, nominal depreciation.
Employer-paid benefits such as medical insurance are not taxed.
This distorts the pay structure towards benefits.
It creates problems such as employer-based medical insurance.
The insurance does not transfer, and creates moral hazard, overuse of insurance, high expenses.
Retirement account incomes are not taxed until withdrawn;
for Roth IRAs, they are not taxed at all, but are not tax deductible.
The Social Security tax is only on payroll income up to some maximum income.
The Supreme Court has recognized that "... 'income'
as used in the statute, should be given a meaning
so as not to include everything that comes in,
as the true function of the words 'gains' and 'profits'
is to limit the meaning of the word 'income.'"
What is "income" in the tax code?
"Income" has to involve profits, not just receipts or revenue.
What is the economic meaning of income?
Consumption plus the change in net worth.
It is referred to as “Haig-Simmons” income.
It is net of all costs, such as inflation.
It includes imputed income, such as the rental value of owner-occupied housing.
The income tax is not adjusted for inflation for interest, depreciation, and capital gains.
There would be fewer distortions if the economic meaning of income were the tax base.
The sales tax base
Most state sales taxes exempt services.
Canada has a six percent tax on goods and services. Exports are exempt.
Sales taxes are applied to final sales, not intermediate sales.
E.g. a store that buys books from a wholesaler.
The following states have no sales taxes:
Alaska, Delaware, Montana, New Hampshire and Oregon.
A resident of California who purchases goods from outside the state is legally required to pay a "use tax." For cars, this is enforced by having to pay an annual registration charge.
The California sales tax exempts unprepared food.
California has a statewide sales tax of 7.25%,
plus local supplementary taxes.
In Santa Clara, the tax is 8.25 percent.
Revenue and Taxation Code, Section 6051.
“For the privilege of selling tangible personal property at retail a tax is hereby imposed upon all retailers at the rate of X percent of the gross receipts of any retailer from the sale of all tangible personal property sold at retail in this state on or after August 1, 1933; ...
Pursuant to the Rev. & Tax Code and the Civil Code, the Purchaser must “agree” to pay
the California “Sales Tax”.
“... for both federal and state tax purposes the [statutory] incidence of the California
sales tax is upon the retailer for the privilege of selling tangible personal property at retail and is not upon the purchaser.” (Sales Tax Act of 1933.)
Value-added tax
Outputs minus inputs.
A major tax in Europe and many other countries.
The tax base is broad.
The firm gets a tax credit on its purchases.
There is less compliance cost than with an income tax, but there can be cheating.
Anther method: the firm reports its value added.
How the tax is applied
tax = rate time base.
rate = tax / base
With a graduated income tax, the rate increases with the tax bracket.
Each tax bracket is a base.
There are several tax rates, depending on the family structure.
A tax exemption means that the income or sales or property is not taxable.
A tax deduction is a subtraction from the taxable base.
For the income tax, you can choose to itemize deductions or take a standard deduction.
There are also high-income phase-outs, decreasing deductions with higher income.
A tax credit is a subtraction from the tax liability.
With a flat income tax, there is one tax rate with no deductions or credits.
The Social Security tax is such a tax.
Some advocates also want to exclude investment and land purchases from a flat tax base.
The effective tax rate is the rate after including exemptions, deductions and credits.
The phase-outs increase the effective marginal tax rates.
The federal income tax rates include a second set of rates, the alternative minimum tax, AMT.
Average tax rate versus marginal tax rates.
Since people decide based on marginal costs and benefits, the marginal tax rate influences decisions the most.
The rich have the highest marginal tax rates, but when it is proposed to reduce the highest rates, some criticize this as tax cuts for the rich, even though the rich pay the most taxes.
Taxation and income
Taxers are regressive, proportional, or regressive as they tax less, the same, or a greater proportion of income with greater income.