Introduction to Taxation

INTRODUCTION TO TAXATION

Unlike most transfers, which are voluntary, taxation is compulsory.

That's needed because of free-rider problem (no one will have injective to contribute)

Modern taxes are monetized (individuals provide just money)

Tariffs are taxes imposed on imported goods. Tariffs protect domestic producers.

Taxes can be divided to:

* direct

* indirect

Direct taxes are individual income tax, payroll tax (used to finance social) security, corporation income tax (tax on net profit of corporations), tax on property.

Indirect taxes are custom duties on imported goods from abroad, exice taxes (telephone services, air travel, luxury commodities).

VAT (Value-added tax) are taxes on the difference of value of sale and value purchased.

Income tax makes a biggest percent in the tax revenue in the USA.

USA relies much more on the individual income tax, unlike EU countries which rely on VAT.

Five properties of a good tax system:

 efficiency (it should not be distortionary)

 administrative simplicity (low cost of administration and complexity)

 flexibility (easy adaptation to changing circumstances)

 political responsibility (it should be transparent)

 fairness (treating those in similar circumstances similarly)

Efficiency - Most taxes change relative prices, so the prices are distorted and the allocation of recourses is inefficient (windows tax in Britain in XVII century)

Behavioral effects of taxation - marriage, divorce, risk taking, saving.

Financial effects of taxation - Fringe benefits, financial structure of firms.

Organizational effects - Corporations vs unincorporated enterprises, banks vs insurance companies.

General equilibrium rate effect is that tax on income reduces saving and reduced saving are reducing capital. Reduced capital means reduced productivity of workers and their wages.

Announcement effects and impact affect also affect tax system.

Nondistortionary taxation - There is nothing that individual or a firm can do to avoid tax liability. These are called lump-sum taxes. Head tax (the one that has to pay regardless of income or wealth), Tax on commodities are distortionary (buying less, paying less tax. Tax on icome are also distortionary taxes.

Corrective taxes are raising revenue and improve efficency of resource allocation (taxes on externalies).

Administrative costs :

- Direct costs (running the Internal revenue service)

- Indirect costs (borne by tax buyers)

Indirect costs are twice times greater than direct. Administrative costs depend of what records would be kept in the absence of taxation and it's complexity.

Flexibility - Changes in economic circumstances require changes in tax rates.

Automatic stabilization - If economy goes into a recession, a reduction of taxes is desirable. When prices are stable, progressive structure will provide automatic stabilization. Indexing taxes in this case are destabilizing economy.

Political difficulties of adjusting rate and speed of adjustment (speed which changes in the tax code can be implemented) effect the flexibility of taxes.

Political responsibility is connected with transparency. Transparency is defined by when it's clear who is benefiting and who is paying. From perspective of transparency, corporation tax is one of the worst, because the one who really payes the tax is not apparent.

Fairness is connected with horizontal equity and vertical equity.

Horizontal equity is where individuals who are the same in the all relevant respects are treated the same. Vertical equity is that some individuals who are in a position to pay higher taxes than other should do so.

Basis of taxation are :

 income (replaced by many countries with VAT which taxes just consumption)

 consumption (C = Y - S)

 lifetime income (present dicounted value of the individuals wage income)

The benefit approach - Individuals should contribute to the support of the government in the proportion to the benfit they receive from public services.

Parreto efficient tax system - Tax structures such that, given the tools and information available to the government no one can be made better of without making someone worse off.

Utilitarianism - The taxation of rich individuals at higher rates than poor individuals. Taxes should be such that marginal utility of income - the loss in the utility from taking a dollar away from and individual should be the same for all individuals.

Utilitarianism may implay horizontal inequity (shipwrecked crew)

Rawlsian Social welfare function - Maximizing the welfare of the worst off individuals.

TAX INCIDENCE

The tax burden is the true economic weight of tax. It is the difference between the individuals real income before and after the tax has been imposed.

Incidence is economic term for burden, that's who actually pays in the sense that their real income is lowered.

If wages fall, tax has been shifted backward. If wages fall by full amount of the tax, they have been fully shifted. If prices rise, tax has been shifted forward.

Taxes are said to be equivalent when taxes are imposed differently but they can have identical effects.

Tax incidence in competitive markets - When tax is imposed, effective cost of production has been increased