tax chapter1

ii) Tax Rate

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

i) Tax Base

- what is actually taxed, usually expressed in monetary terms

a) Tax =

-------Tax Base x Tax Rate

b) Earmarked tax

------is a tax that is assessed for a specific purpose

iv) Income Effect

: As tax rates go up, people will work harder to maintain same after-tax income.

b) Transfer taxes

: The estate tax and gift taxes are based on the fair market values of wealth transfers upon death or by gift, respectively

iii) Vertical Equity

: taxpayers with greater ability to pay tax, pay more tax relative to taxpayers with a lesser ability to pay tax. Vertical equity can be viewed in terms of tax dollars paid or tax rates. Vertical equity may also be evaluated using effective tax rates instead of simply considering the tax rate structure

ii) Horizontal Equity

: two taxpayers in similar situations pay the same tax.

v) Substitution Effect:

As tax rates go up, people will substitute non-taxable activities because the marginal value of taxable ones has decreased. i) A tax system is considered fair or equitable if the tax is based on the taxpayer's ability to pay.

---------- alcohol, diesel fuel, gasoline, and tobacco products and on services such as telephone use and air transportation

Excise taxes

7) Evaluating alternative tax systems iii) Dynamic forecasting

Forecasting which tries to predict possible responses by taxpayers to new tax laws.

---------------federal and state income taxes and federal estate and gift taxes

Progressive tax

----------------a sales tax

Proportional tax

---------------the Social Security tax employs

Regressive tax

iii) Flat taxes iv) Graduated taxes v) Brackets

a single tax applies entire base constitute a base is diverted I to series of monetary amount

d) Convenience

i) A tax system should be designed to be collected without undue hardship to the taxpayer

e) Economy

i) A tax system should minimize the compliance and administration costs associated with the tax system

b) Average tax rate

i) Definition - a taxpayer's average level of taxation on each dollar of taxable income ii) Formula - iii) Useful in budgeting tax expenses or comparing the relative tax burdens of taxpayers

a) Proportional tax rate structure

i) Definition - also known as a flat tax, imposes a constant tax rate throughout the tax base. ii) As the tax base increases, the taxes paid increase proportionally. iii) The marginal tax rate remains constant and equals the average tax rate across the tax base iv) The most common example of a proportional tax is a sales tax.

c) Regressive tax rate structure

i) Definition - imposes a decreasing marginal tax rate as the tax base increases. ii) As the tax base increases, the taxes paid increases, but the marginal tax rate decreases. iii) Regressive tax rate structures are not common. In the United States, only the Social Security tax employs a regressive tax rate structure

b) Progressive tax rate structure

i) Definition - imposes an increasing marginal tax rate as the tax base increases. ii) As the tax base increases, both the marginal tax rate and the taxes paid increase. iii) Common examples of progressive tax rate structures include federal and state income taxes and federal estate and gift taxes

a) Marginal tax rate

i) Definition - tax rate that applies to the next additional increment of a taxpayer's taxable income (or deductions) ii) Formula - = iii) Useful in tax planning

c) Effective tax rate

i) Definition - taxpayer's average rate of taxation on each dollar of total income, including taxable and nontaxable income ii) Formula - iii) Provides the best depiction of a taxpayer's tax burden d) Work example in power point slides calculating tax liability, marginal, average, and effective tax rates

6) Types of taxes a) Federal taxes

i) Income tax: imposed on individuals, corporations, estates and trusts. The largest federal tax. ii) Employment taxes: Employment taxes consist of the OASDI tax (Social Security tax) and the MHI tax (Medicare tax). The tax base for these taxes is wages or salary and employers and employees split these taxes equally. Self-employed individuals must pay these taxes in their entirety. iii) Unemployment taxes: Employers are also required to pay federal and state unemployment taxes, which fund temporary unemployment benefits for individuals terminated from their jobs without cause. iv) Excise taxes: A tax based on quantity of goods or services purchased. Common examples include taxes on alcohol, diesel fuel, gasoline, and tobacco products and on services such as telephone use and air transportation

c) State and local taxes

i) Income tax: most states impose an income tax. The calculation varies by state. ii) Sales and use taxes: the tax base for a sales tax is the retail sales of goods and some services. Retailers collect and remit this tax. The tax base for the use tax is the retail price of goods owned, possessed or consumed within a state that were not purchased within the state. The purpose of a use tax is to discourage taxpayers from buying goods out of state in order to avoid or minimize the sales tax in their home state. iii) Property taxes: assessed on the fair market value of real property and personal property. These are ad valorem taxes. iv) Excise

d) Implicit taxes

i) Indirect taxes that result from a tax advantage the government grants to certain transactions. ii) Defined as the reduced before-tax return that a tax-favored asset produces because of its tax advantaged status iii) Difficult to quantify but important to understand in evaluating the relative tax burdens of tax-advantaged investments iv) Walk through examples of implicit taxes in text

h) Evaluating tax systems - the trade-off

i) Much of the debate regarding alternative tax systems reduces to a choice between simplicity and fairness. Those taxes that generally are simpler and easier to administer are typically viewed as less fair. Those taxes that may be viewed as more fair are often are more complex to administer.

c) Certainty

i) Taxpayers should be able to determine when to pay the tax, where to pay the tax, and how to determine the tax

g) Compare the income tax and sales tax

using the equity, certainty, convenience, and economy criteria

a) Definition of a tax

• payment is required • tax is imposed by a government agency (federal, state, local) • tax is not directly to the benefit received by the taxpayer National defense, judicial system, law enforcement, government sponsored social programs, highway systems, public schools, etc., are benefits we receive from paying taxes; however, the taxes we pay are not directly related to any specific benefit received by taxpayer