8.7- Tax Policy

Oct 21, 2024

Tax Codes Overview

Purpose of Taxes

  • Raising Revenue: To fund programs not easily provided by markets (e.g., defense, education).
  • Transfer Payments: Redistribution of income, mainly for the elderly through social security and Medicare.
  • Government Operations: Finance the running of the government, including salaries.
  • Correcting Market Failures: Address situations where markets may not provide optimal goods.

Types of Taxes

  • Federal Government:

    • Individual Income Taxes: Filled annually by individuals.
    • Payroll Taxes: Fund transfer programs, deducted from paychecks (FICA line).
    • Corporate Income Taxes: Levied on corporate profits, economic incidence borne by people (owners, workers, consumers).

  • State and Local Governments:

    • State Taxes: Mix of income and sales taxes.
    • Local Taxes: Depend on property taxes on land and structures.

Key Tax Terms

  • Average Tax Rate: Total taxes paid divided by income.
  • Marginal Tax Rate: Taxes paid on an additional dollar earned.

Example Tax System

  • Zero tax rate for the first $50,000 of income.
  • 50% tax rate on income above $50,000.
  • Impact on different income levels:
    • $40,000 Income: Zero tax, marginal and average rates are 0%.
    • $50,000 Income: Marginal rate is 50%, still zero dollar tax.
    • $100,000 Income: Total tax is $25,000, average rate is 25%, marginal rate is 50%.

Decision Making and Marginal Rate

  • Marginal Rates influence decisions to work and save.
  • Example of Tracy:
    • $40,000 income, zero average and marginal rates, unaffected by taxes.
    • $50,000 income, marginal rate 50%, affects decision to take extra work due to opportunity cost.

Tax Code Types

  • Progressive Tax: Increasing average rates with income.
  • Proportional Tax: Constant average rates.
  • Regressive Tax: Decreasing average rates with income.

Characteristics of U.S. Tax Code

  • Extremely progressive federal tax code compared to other countries.

Further Study

  • Focus on public finance or public economics for detailed exploration of taxes and government spending policies.