Federal Income Taxation
I. Introduction to Income Tax: Chapter 1, p. 1-38
a. General Principles:
i. Constitutional Power to Tax – based on Art. I, §8, cl.1 which provides that “The Congress shall have Power to lay and collect Taxes, Duties, Imposts, and Excises, to pay the Debts and provide for the common Defence and general Welfare of the United States.”
1. 16th Amendment granted power to impose direct income taxes without apportionment
2. Led to passage of a series of Internal Revenue Codes, most recent overall code enacted in 1986
ii. Taxing Income – Income = Consumption + Δ Wealth
1. Why tax income? More tied to ability to pay, increased perception of fairness
a. We want people to actually pay a fair amount, also want to make sure there’s a strong perception of fairness
b. Criticism of Income Tax – discriminates against savers
c. Arguments in Favor – better reflects changes in wealth
2. Fewer problems than with alternative schemes
a. Head tax – not necessarily fair or efficient
b. Poll Tax – very arbitrary
c. Excise/Consumption taxes – based on how much you spend
i. We do have consumption-style elements
ii. Applies unfairly to those who consume most of their income, over-preferences savings
d. Value added taxes
e. Excise taxes, taxes on certain activities, user fees – very arbitrary, might over-tax those who can afford the tax least
f. Property taxes – but fundamentally a wealth tax
i. Might help prevent/mitigate concentrations of wealth
ii. But might disincentivize saving
g. Gift/estate taxes
h. Import/Export duties
i. Tax on Wages – pushes burden onto those who earn all income through wages, as opposed to passive income
j. Cash only taxes – would just tax liquidity, encourage non-cash based economy
k. Gross receipt taxes – taxes everything that comes in without deducting cost of generating income
i. Would prob discourage investment, incurring important expenses
ii. Disincentivizes capital improvements
iii. Sources of Tax Law
1. Internal Revenue Code
2. IRS and Treasury Regulations
3. Revenue Rulings – Office view of answer to a tax issue, not necessarily given great deference by courts
4. Revenue Procedures – outlining procedural rules for calculating taxes
5. Private Letter Rulings – series of opinions issues by IRS on details/ramifications of a particular transaction, only good for particular situation
6. Technical Advice
iv. Judicial Options – a number of options, provides flexibility for taxpayers but also may lead to confusion and decentralization. Govt is always a party in tax suits, and that raises additional issues for tax challenges
1. Taxpayers (TPs) can contest a notice of deficiency by filing petition in US Tax Court, where case is tried by Tax Court judge
income tax
i. Income effect – TPs may work more in order to have the same amount of money left after tax, work more to net same amount
ii. Substitution effect – TPs may substitute non-taxed leisure for work, so they can pay less tax by earning less, work less to pay less in taxes
c. Incidence – who really bears the burden of a tax?
i. Real incidence falls on the person who bears the burden
ii. Nominal incidence falls on the person who pays the bill
d. Tax Capitalization – mechanism by which market responds to different tax treatments of economically identical transactions
i. Tax preferences on certain actions/assets may be capitalized/equalize over time
e. Deadweight loss – hidden cost of a tax, loss in overall welfare caused by change in behavior of TPs who avoid the tax
i. May change behavior to avoid tax, not paying tax but worse off because of changing behavior, and gov’t isn’t benefiting b/c not even collecting tax revenue
f. Simplicity – try to have a simple tax system if possible. Complexity is bad if:
Tax system’s enforcement costs are greater than the revenues collected through enforcement
