ECON 369

Outline Eleven - Other Taxes and Tax Ideas

Before we leave the revenue side of the budget - let's go over a few more taxes and tax ideas that you might want to consider for your project:

The Green Tax

            Environmental tax reformers argue that the U.S. could achieve a more efficient tax system by reducing taxes on income and consumption and raising taxes on pollution. 

Tax activities that should be discouraged, not those that should be encouraged, like work.

Most economists doubt that the green tax can form the basis for comprehensive tax reform: 

1.  they are not sufficiently broad-based to raise enough revenue to replace the income tax. 

2.  they are likely to be regressive.  Example:  the carbon tax (on carbon dioxide – a tax on the carbon content of fossil fuels) would (according to one study by MIT econ. James Poterba) impose a tax burden that is more than six times as high relative to income for taxpayers in the lowest income decile as for those in the highest income decile.

Are these reasons not to institute the taxes?

Taxes on Wealth

            Income and wealth are different measures of ability to pay.  A person can have high income and little wealth or vice versa, although the two are usually positively correlated. 

The broadest measure of personal wealth is net worth, which is the value of a family’s assets minus its liabilities.  It is a measure at a point in time.

A personal wealth tax is advocated by some due to the unequal distribution of wealth.  However, they are hard to administer and are not a major source of revenue for countries that have them.

A one-time tax on wealth is a lump-sum tax that does not distort economic decisions – in theory.  People would save more for the future after being taxed.

But would people believe that it is a one-time tax?  Probably not.  This would discourage saving.  Also, those who earned the same income but spent it would pay no tax, while those who saved would bear the burden of the tax.  Not exactly a good signal to people (unless you are  a Keynesian economist).

Taxes on Transfers of Wealth

            A taxpayer’s death can trigger certain taxes:  the estate tax levied by the federal government and the estate and inheritance taxes levied by the states.

An estate tax is levied on the net worth of a decedent, whereas an inheritance tax is levied on the amount received from an estate by an heir.  These two taxes are commonly lumped together and called death taxes.

The federal estate tax is levied on the amount of the taxable estate according to a graduated tax rate schedule.  An estate left to a surviving spouse is not subject to the tax.  Money left to charities is also not taxed.

An obvious incentive provided by a tax on transfers of wealth at death is for taxpayers to arrange to transfer wealth before dying by making gifts to their heirs. 

So the government levied a gift tax!

These do not raise a large proportion of revenue for the federal government – partially due to tax avoidance.  Estate planning is big business for tax accountants and lawyers.

Some might argue that estate taxes are “fair” – in the sense that everyone starts out the race equal instead of with a large inheritance they did not earn.  On the other hand, if these taxes discourage productivity (because people might work harder in order to leave something to their kids, etc.), then overall economic growth would decline.

Taxes on Land and Site Value

            Taxes on real estate property are the main form of wealth taxation in the United States.  Most property tax revenue is collected by local governments.  When the value of a property is determined, the amount of tax is found by multiplying the assessed value of the property by the levy rate.  The levy rate is usually expressed as dollars of tax per $1000 of assessed value, but it is sometimes expressed as the mill rate. 

Levy rates in different jurisdictions cannot be easily compared, because some jurisdictions have a high levy rate but low assessed values, or vice versa.  In some jurisdictions, the assessed value is equal to the market value of the property, whereas others use fractional assessments that value property at less than market value.

The problem:  this requires an assessment process.  The value of a piece of land depends, among other things, on its location and amenities.  To tax the value of land holdings, the government would need to determine the market value of each piece of land in every tax year.  Unless sold, the value must be “imputed.”  At the federal level – this would require an army of assessors – to greater intrusions on privacy than results from the IRS (maybe).

Some Economic Effects of a Property Tax:

Even if the supply of land is fixed,

(1) the levy rate may differ according to the use of the land, so the property tax affects how land is used.  For instance, a higher effective levy rate may apply if the land is used for residential purposes than if it is used for agricultural purposes.  In this case, the property tax discourages the use of land for residential purposes. 

(2)  Also, vacant unimproved land has a lower value than improved land (cleared, etc.).  If landowners plan to hold land for some length of time, the existence of the property tax encourages them to hold it in unimproved form.

(3)  Perhaps the most important effect of the property tax is on the quantity of structures.  Although the quantity of structures is fixed at a point in time, it can vary over time because of new construction and depreciation of existing structures.  Since the value of the structures is taxed by the property tax, the property tax acts to reduce the quantity of structures. 

(4)  Jurisdictions:  if some jurisdictions levy higher taxes on property than neighboring jurisdictions, new homeowners may be encouraged to locate and build in the lower-tax jurisdictions.  This view has been challenged by the argument that the property tax is a benefit tax (the taxpayer gets a benefit of equal value).  For example – higher property taxes, better schools.  What if the property owner does not have children (like Deb)? (:

(5)  Some believe this tax would reduce urban sprawl and revitalize inner cities.  By taxing land, households would be less inclined to demand large parcels of property with their homes, reducing flight to the suburbs.  Residential density would be increased.  If improvements are not taxed, incentives would be greater for rehabilitating existing properties within the cities.

More Jurisdiction Ideas

Tax Exporting:  when the burden of a tax is shifted to someone outside the jurisdiction.

Ideally, politicians would like to levy taxes that burden people who cannot vote in elections.  How do state and local governments do this?

1. Federal Offsets: made possible because taxpayers who itemize their federal income taxes can deduct state and local income and property taxes.

Example:  a New York family in the 28% federal tax bracket pays $5000 in deductible state and local taxes, it saves $1400 in federal personal income taxes by taking the deduction, which reduces its taxable income by $5000.  In effect, federal taxpayers pays part of the family’s state and local taxes.  Of course, to offset this, the feds levy a higher tax rate, so the cost of the $1400 tax saving to the New York family is exported to the taxpayers of the country at large.

2. Taxing particular goods and services likely to be purchased by out-of-state consumers or visitors to the state.  

Example:  higher sales taxes on hotel rooms.

Tax Competition: occurs when a local government sets its tax rate marginally below the tax rates prevailing in other localities in order to attract the tax base – say, business and personal income – into its jurisdiction.  By “stealing” another locality’s tax base, a low-tax jurisdiction can collect more revenue despite its lower tax rates.

But once one jurisdiction does this, another may retaliate and lower rates even further.  In the end, both states might lose revenue.  Although some taxpayers gain from tax competition, the states must raise revenues in other ways where tax competition is not possible.  These alternative taxes may do even more harm.

In the extreme case, tax competition may limit local taxing jurisdictions to benefit taxes.  These taxes do not cause people to change locations.  Again, a benefit tax is difficult to levy across the entire population.

And finally -- you should really consider the following when discussing your tax plan in your project:

Tax “Avoison” by Gordon Tullock

Tax Avoidance:  taking measures to reduce tax liability that are perfectly legal.

            Example:  homeowner exemption

Tax Evasion:  taking measures to reduce tax liability that are not legal.

            Example:  underreporting income

Both have implications for resource allocations for society.

Avoison:  Both avoidance and evasion.

Tax Avoidance

The Home Mortgage Decision:  Would people buy houses anyway?  If yes, then there’s no cost in terms of allocating resources differently.  There is the cost of the tax bureaucracy and tax industry.

If the tax changes people’s behavior – they buy and sell every time they move, this is a cost that is caused by the tax.

The Economic Incidence (costs) of Loopholes

1)       Some pay more than others (those who take advantage of the loopholes and those who do not).  The government provides the same set of services but the cost is distributed in a different way among taxpayers through the tax system.

2)       The economy is distorted by the existence of the tax advantage.   Resources move where they otherwise would not move - assuming that the loophole does create incentives for people to try to avoid taxes.

3)       Some may choose more leisure over work – because leisure is not taxed but working is.  The allocation of time between work and leisure might cause a social loss.  The cost is the production that is lost.

4)       People may not work as hard.  Similar results as above.

Special Services for the Tax Industry

Another economic incidence (cost) of tax avoidance is that a very large number of industries exist solely for the purpose of providing tax exemptions – or their size is much larger than it otherwise would be.

Tax accountants and lawyers, resorts for conferences, real estate, etc.

Corporate Structure as a Response to the Tax System

The structure of the corporation can be changed to decrease tax obligations.

As we discussed - Since corporate stock is taxed while corporate bond interest is deductible – corporations are more likely to finance through debt rather than equity (when they otherwise wouldn’t for efficiency reasons).

Tax Evasion

The terms “black market” or “underground economy” describes the activities used by people to evade taxes (especially the income tax).

Basically it is underreporting of income (or payment of income in the case of a payroll tax)  in some way or another.

The Cost of the Underground Economy

Tullock:  doesn’t object to the tax avoison but to the activities themselves.  If they were taxed, the profits from such illegal activities would be lower and hence the profits would go down and fewer people would enter the “industry.” 

But why should fewer people be in any given industry?

Repairman example:  Hire a repairman instead of taking off work to do it yourself.  The quality of the work is higher and society doesn’t lose your lost productivity.  Since he is not going to report the income, he will do it for less money (the real market price).

Should we object to this tax evasion?

Your answer may depend upon whether you think the government needs the money.

Economic incidence of Tax Avoison

It is difficult to know the cost of tax avoision.  It depends upon:

1)       will the government increase tax bases (keeping tax revenue the same)

2)       if so, what will the government use the money for (reducing another tax?)

3)       if not, are we better off with a smaller amount of revenue going to the government

4)       an underground economy is productive – is it more productive because those involved in it do not pay taxes

5)       are those involved in the underground economy free-riding off others

6)       what about the cost of enforcing the tax code

7)       what about the cost of complying (or not complying) with the tax code

Conclusion:  there are no clear answers.

 DO ICE TWELVE

Supply-Side Economics and Taxes

A main character:  Arthur Laffer and others

Supply-side economists focus on incentives -- especially the incentive to work or not.  Their main assumption is that people work more if their wage is increased (in general).  Therefore, cutting taxes (increasing wages) will lead to more work effort, a larger tax base, and therefore, more tax revenue.  This is based upon the assumptions regarding the theory surrounding the “Laffer Curve.”

Incentives and work -- which is correct:

Substitution Effect:

Income Effect:

GRAPH: (supply curve of labor)

The Laffer Curve (the relationship between tax rates and tax revenue): GRAPH

The Theory:

If the government increases marginal tax rates, that will decrease additional income that earners keep, thereby affecting output (productivity) for 2 reasons:

1. ­ Marginal tax rate increases, this decreases the payoff people derive from work (for example, when this occurs many with working spouses opt out of the labor force), less work, less productivity (incentives have changed – people choose leisure over work in the labor/leisure trade-off).

2. ­ Marginal tax rate increases, people (including those operating businesses) turn to tax shelter investments to avoid excess taxes (for example, investments that generate paper losses from depreciated assets) or move their businesses to places where tax rates are lower .  Therefore people are spending resources on tax avoidance (or tax evasion) instead of on productive activities. Real productivity is lower than it could be because resources are wasted producing goods that are valued less than their cost of production -- many goods are produced that otherwise would not have been produced if it wasn't for people trying to avoid taxes.  Those resources could have produced goods that actually made peoples lives better off (in absence of the taxes).

Trickle Down: 

Policy Conclusions:

Cut income taxes in order to increase tax revenue (through an increase in productivity and tax collection).

The main supply-side (tax cut) effects are:

• increase in business activity
• reduction in tax "avoision"

And therefore: there is an increase in the tax base and therefore, possibly, also an increase in tax revenue.

The rich pay more:  Furthermore, there is an increase in the share of income tax paid by high income taxpayers when the higher bracket tax rates are cut (i.e., the rich end up paying more of the total tax bill).

In The Way The World Works, Jude Wanniski, one of the leading gurus of the "supply-side" school, calls for  discovering the actual shape of the "Laffer Curve."

That part of "The Curve" at which government revenue is maximized should be pinpointed and fiscal policy implemented to assure that the economy is moved to that point without further delay.

The "Curve" aside - the supply-side argument can be seen as a long-run strategy to increase economic growth, not a short-run policy tool to deal with a recession, for example.

Empirical Evidence

From History - the U.S.:  Four major income tax cuts in the United States -

Keep in mind that tax revenue collected by the U. S. federal government has typically increased over time.  The question is - does it increase at a higher rate after a major income tax cut.  According to data, it does.  Numbers from the U.S. Budget Office.

1922-1928 (Coolidge Tax Cuts)

When the federal income tax was enacted in 1913, the top rate was just 7 percent. By the end of World War I, rates had been greatly increased at all income levels, with the top rate increased to 77 percent (for income over $1 million). After five years of high tax rates, rates were cut sharply under the Revenue Acts of 1921, 1924, and 1926. The combined top marginal normal and surtax rate fell from 73 percent to 58 percent in 1922, and then to 50 percent in 1923 (income over $200,000). In 1924, the top tax rate fell to 46 percent (income over $500,000). The top rate was just 25 percent (income over $100,000) from 1925 to 1928, and then fell to 24 percent in 1929.

So the top marginal tax rates were cut from 73% to 25% (-48%).

Revenues received by the federal treasury increased from $719 million in 1921 to more than $1.1 billion 1929. That's a 61% increase (there was zero inflation in this period).

Real tax revenue collected from incomes of $50,000 and above increased from $305.1 million to $481.1 million (+63%). Real tax revenue collected from those who made less than $50,000 dropped by 45%.

1963-1965 (Kennedy Tax Cuts)

JFK’s tax cuts were passed in the summer of 1964. The top marginal tax rates were reduced from 91% to 70%. The bottom rates were reduced from 20% to 14%.

From 1965 to 1968, total federal revenue rose by 30%, from $117 billion to $153. 

Tax revenues of the bottom 95% of taxpayers fell from $31 billion to $29.6 billion (-4.5%). Tax revenues of the top 5% of taxpayers rose from $17.2 billion to $18.5 billion (+7.6%).
 

1981-1986 (Reagan Tax Cuts -- supply-side tax cuts)

Top U.S. federal income tax rates declined from 70% to approx. 33% (and was 28% when he left office).

Tax payments and the share of income taxes paid by the top 1% climbed sharply. For example, in 1981 the top 1% paid 17.6% of all personal income taxes, but by 1988 their share had jumped to 27.5%, a 10 percentage point increase.  The share of the income tax burden borne by the top 10% of taxpayers increased from 48.0% in 1981 to 57.2% in 1988. Meanwhile, the share of income taxes paid by the bottom 50% of taxpayers dropped from 7.5% in 1981 to 5.7% in 1988.

2003-2008 (Bush Tax Cuts - supply-side tax cuts)

Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRAA) and Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA)

JGTRRA accelerated the gradual rate reduction and increase in credits passed in EGTRRA. The maximum tax rate decreases originally scheduled to be phased into effect in 2006 under EGTRRA were retroactively enacted to apply to the 2003 tax year. In addition, the child tax credit was increased to what would have been the 2010 level, and "marriage penalty" relief was accelerated to 2009 levels.

There were also capital gains tax cuts in both.

The Bush tax cuts had sunset provisions that made them expire at the end of 2010. But were extended by a two-year extension that was part of a larger tax and economic package, the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010.

Criticisms of the Theory