Chapter 1 Introduction to Tax

Regressive Tax Rate Structure

a tax rate structure that imposes a decreasing marginal tax rate as the tax base increases - as the tax base increases, the taxes paid increase, but the marginal tax rate decreases

Progressive tax rate structure

a tax rate structure that imposes an increasing marginal tax rate as the tax base increases - as the tax base increases, both the marginal tax rate and the taxes paid increases

Average tax rate

a taxpayer's average level of taxation on each dollar of taxable income Average tax rate = Total tax / Taxable income

Effective Tax Rate

the taxpayer's average rate of taxation on each dollar of total income (taxable and nontaxable income) Effective tax rate = Total tax / Total income

Income tax

a tax in which a tax base is income - income taxes are imposed by the federal government and by most states

Personal Property tax

a tax on the fair market value of all types of tangible and intangible property, except real property

Self-Employment Taxes

Social Security and Medicare taxes paid by the self-employed on a taxpayer's net earnings from self-employment - for self-employed taxpayers, the term "self-employment tax" and "FICA tax" are synonymous

Describe the different tax rate structures and calculate a tax

Tax = Tax rate x Tax base, where the tax base is what is taxed and the tax rate is the level of taxes imposed on the base - different potions of a tax base may be taxed at different rates there are three different tax rates that are useful in assessing the different tax rate structures, tax planning, and/or the tax burden of a taxpayer: the marginal, average, and effective tax rates the marginal tax rate is the tax that applied to the next increment of income or deduction - the average tax rate represents a taxpayer's average level of taxation on each dollar of taxable income - the effective tax rate represents the taxpayer's average rate of taxation on each dollar of total income (taxable and nontaxable income) the three basic structures are proportional, progressive, and regressive a proportional tax rate structure imposes a constant tax rate throughout the tax base - as a taxpayer's tax base increases, the taxpayer's taxes increase proportionally - the marginal tax rate remains constant and always equals the average tax rate - a common example is sales tax a progressive tax rate imposes an increasing marginal tax rate as the tax base increases - as a taxpayer's tax base increases, both the marginal tax rate and the taxes paid increase - a common example is the U.S. federal income tax a regressive tax rate imposes a decreasing marginal tax rate as the tax base increases - as a taxpayer's tax base increases, the marginal tax rate decreases while the total taxes paid increases

Real Property tax

a tax on the fair market value of land and structures permanently attached to land

Tax

a payment required by a government that is unrelated to any specific benefit or service received from the government

Sufficiency

a standard for evaluating a good tax system - sufficiency is defined as assessing the aggregate size of the tax revenues that must be generated and ensuring that the tax system provides these revenues

Bracket

a subset (portion) of the tax base subject to a specific tax rate - brackets are common to graduated taxes

Earmarked tax

a tax assessed for a specific purpose (e.g., for education)

State tax

a tax imposed by one of the 50 U.S. states

Value-Added Tax

a tax imposed on the producer of goods (and services) based on the value added to the goods (services) at each stage of production - value-added taxes are common in Europe

Sales Tax

a tax imposed on the retail price of goods (plus certain services) - retailers are responsible for collecting and remitting the tax - typically, sales tax is collected at the point of sale

Use Tax

a tax imposed on the retail price of goods owned, possessed, or consumed within a state that were not purchased within the state

Flat tax

a tax in which a single tax rate is applied throughout the tax base

Proportional tax rate structure

also known as a flat tax, this tax rate structure imposes a constant tax rate throughout the tax base - as the tax base increases, the taxes paid increases proportionally

Identify the various federal, state, and local taxes

federal taxes include the income tax, employment taxes (social security and medicare taxes), unemployment taxes, excise taxes (levied on quantity purchased), and transfer taxes (estate and gift taxes) state and local taxes include the income tax (levied by most states), sales tax (levied on retail sale of goods and some services), use tax (levied on the retail price of goods owned or consumed within a state that were purchased out of state), property taxes (levied on the fair market value of real and personal property), and excise taxes implicit taxes are indirect taxes that result from a tax advantage the government grants to certain transactions to satisfy social, economic, or other objectives - they are defined as the reduced before-tax return that a tax-favored asset produces because of its tax-advantaged status

Implicit taxes

indirect taxes that result from a tax advantage the government grants to certain transactions to satisfy social, economic, or other objectives - they are defined as the reduced before-tax return that a tax-favored asset produces because of its tax-advantaged status

Equity

one of the criteria used to evaluate a tax system - a tax system is considered fair or equitable if the tax is based on the taxpayer's ability to tax - taxpayer's with a greater ability to pay tax, pay more tax

Convenience

one of the criteria used to evaluate tax system - convenience means a tax system should be designed to facilitate the collection of tax revenues without undue hardship on the taxpayer or the government

Certainty

one of the criteria used to evaluate tax systems - certainty means taxpayers should be able to determine when, where, and how much tax to pay

Economy

one of the criteria used to evaluate tax systems - economy means a tax system should minimize its compliance and administration costs

Horizontal Equity

one of the dimensions of equity - horizontal equity is achieved if taxpayers in similar situations pay the same tax

Vertical equity

one of the dimensions of equity - vertical equity is achieved when taxpayers with greater ability to pay tax, pay more tax relative to taxpayers with a lesser ability to pay tax

Income effect

one of the two basic responses that a taxpayer may have when taxes increase - the income effect predicts that when taxpayers are taxed more (e.g., tax rate increases from 25 to 28 percent), they will work harder to generate the same after-tax dollars

Substitution effect

one of the two basic responses that a taxpayer may have when taxes increase - the substitution effect predicts that, when taxpayers are taxed more, rather than work more, they will substitute nontaxable activities (e.g., leisure pursuits) for taxable ones because the marginal value of taxable activities has decreased

Apply appropriate criteria to evaluate alternative tax systems

sufficiency involves assessing the aggregate size of the tax revenues that must be generated and ensuring that the tax system provides those revenues - static forecasting ignores how taxpayers may alter their activities in response to a proposed tax law change and bases projected tax revenues on the existing state of transactions - in contrast, dynamic forecasting attempts to account for possible taxpayer responses to a proposed tax law change equity considers how the tax burden should be distributed across taxpayers - generally, a tax system is considered fair or equitable if the tax is based on the taxpayer's ability to pay; that is, taxpayers with a greater ability to pay tax, pay more tax - horizontal equity means that two taxpayers in similar situations pay the same tax - vertical equity is achieved when taxpayers with greater ability to pay tax, pay more tax relative to taxpayers with a lesser ability to pay tax certainty means taxpayers should be able to determine when, where, and how much tax to pay convenience means a tax system should be designed to facilitate the collection of tax revenues without undue hardship on the taxpayer or the government economy means a tax system should minimize its compliance and administration costs

Demonstrate how taxes influence basic business, investment, personal, and political decisions

taxes are significant costs that influence many basic business, investment, and personal decisions business decisions include what organizational form to take, where to locate, how to compensate employees, determining the appropriate debt mix, owning versus renting equipment and property, how to distribute profits, and so forth investment decisions include alternative methods for saving for education or retirement, and so forth personal financial decisions include evaluating job offers, gift or estate planning, owning a home versus renting, and so forth taxes also play a major part in the political process - major parties typically have very diverse views on whom, what, and how much to tax

Ad valorem taxes

taxes based on the value of property

Employment Taxes

taxes consisting of the Old Age, Survivors, and Disability Insurance (OASDI) tax, commonly called the Social Security tax, and the Medical Health Insurance (MHI) tax, known as the Medicare tax

Explicit Taxes

taxes directly imposed by a government

Local Tax

taxes imposed by local governments (cities, counties, school districts, etc.)

Sin taxes

taxes imposed on the purchase of goods (e.g., alcohol, tobacco products, etc.) that are considered socially less desirable

Graduated Taxes

taxes in which the tax base is divided into a series of monetary amounts, or brackets, where each successive bracket is taxed at a different (gradually higher or gradually lower) percentage rate

Excise Taxes

taxes levied on the retail sale of particular products - they differ from other taxes in that the tax base for an excise tax typically depends on the quantity purchased rather than a monetary amount

Transfer taxes

taxes on the transfer of wealth from one taxpayer to another - the estate and gift taxes are two examples of transfer taxes

Medicare tax

the Medical Health Insurance (MHI) tax - this tax helps pay medical costs for qualifying individuals - the medicare tax rate for employees and employers is 1.45% on salary or wages - an additional 0.9% is assessed on employees (not employers) on salary or wages in excess of $200,000 ($125,000 for MFS; $250,000 of combined salary or wages for MFJ) - self-employed taxpayers pay both the employee and employer Medicare tax and additional Medicare tax

Social Security tax

the Old Age, Survivors, and Disability Insurance (OASDI) tax - the tax is intended to provide basic pension coverage for the retired and disabled - employees pay social security tax at a rate of 6.2% on the wage base (employers also pay 6.2%) - self-employed taxpayers are subject to a social security tax at a rate or 12.4% on their net earnings from self-employment - the base on which social security taxes are paid is limited to $132,900 of wages and/or net earnings from self-employment

Discuss what constitutes a tax and the general objectives of taxes

the general purpose of taxes is to fund the government - unlike fines or penalties, taxes are not meant to punish or prevent illegal behaviors, but "sin taxes" (on alcohol, tobacco, tanning beds, etc.) are meant to discourage some behaviors to qualify as a tax, three criteria are necessary: the payment must be (1) required (it is not voluntary), (2) imposed by a government (federal, state, or local), and (3) not tied directly to the benefit received by the taxpayer

Tax base

the item that is being taxed (e.g., purchase price of a good, taxable income, etc.)

Tax rate

the level of taxes imposed on the tax base, usually expressed as a percentage

Static Forecasting

the process of forecasting tax revenues based on the existing state of transactions while ignoring how taxpayers may alter their activities in response to a tax law change

Dynamic Forecasting

the process of forecasting tax revenues that incorporates into the forecast how taxpayers may alter their activities in response to a tax law change

Estate Tax

the tax paid for an estate

Gift tax

the tax paid on a gift

Marginal tax rate

the tax rate that applies to the next additional increment of a taxpayer's taxable income (or to deductions) Marginal tax rate = Change in tax / Change in taxable income Marginal tax rate = (New total tax - Old total tax) / (New taxable income - Old taxable income) "old" refers to the current tax, and "new" refers to the revised tax after incorporating the additional income (or deductions) in question

Unemployment Tax

the tax that pays for temporary unemployment benefits for individuals terminated from their jobs without cause