Tax 1A Outline
1. Calculate gross income (§61)
2. Subtract above-the-line deductions (§62) to obtain adjusted gross income.
3.Subtract the below-the-line deductions = the sum of personal expenditures (§151 & §152) and either the standard deduction or itemized deductions (start w/ §63 & §67). The resulting figure is taxable income under (§63).
4. Apply the tax rate schedule (found in §1) to taxable income to determine tentative tax liability.
5. Subtract from tentative tax liability any available tax credits to determine final tax liability.
A. Basic Goals and Policies of an Income Tax
Objectives of a tax system:
1. Raise Revenues: govt’s expenses (public goods, transfer payments) must be paid, either through:
– pay now, through taxes
– pay later through borrowing (long-term implications)
– print money – (long term implications)
2. Regulatory Function: Encourage (homeownership through deduction for mortgage interest) or discourage (sin tax, excise taxes) certain behaviors.
3. Supplement fiscal policy objectives – by reducing or increasing taxes, the economy may be stimulated in times of economic slowdown or deflated in times of inflation.
4. Affect income and wealth distribution – reduce the disparities in economic wealth among people.
5. Achieve Economic goals — special provisions may encourage investment in particular economic activities,such as investment in new machinery, new technology, etc.
Goals of a Tax System from a Normative Point of View:
1. Equity: For a tax to be fair, it should not impose significant different burdens on persons in similar economic circumstances.
– Horizontal Equity: equals should be treated equally. I.e. people similarly situated should pay equal amounts of tax. An income tax thus reflects the judgment that people w/ equal incomes should be taxed equally (though they may not technically be “similarly situated”).
– Vertical equity: differently situated TPs should bear appropriately different tax burdens. So TPs w/ greater income would pay greater amounts of income tax.
2. Efficiency (two meaning):
– Allocation of resources. Any tax has an efficiency cost b/c it alters the relative values of labor, capital and leisure, thereby affecting the allocation of resources. A tax system should interfere as little as possible w/ people’s economic behavior.
– Can also refer to the extent to which subsidies in the form of tax provisions are actually received by the intended beneficiaries.
3. Simplicity: Tax rules are inefficient b/c TPs must divert time from other activities in order to calculate their taxes (or earn the money to pay for professional tax assistance) and b/c the govt must maintain a la
(2) Bottom rate 10%, (3) some pay 0%.
Other tax systems:
1. Schanz-Haig-Simons (SHS): defines personal income as the sum of consumption and accumulation. Income includes savings as well as consumption. A more pure income tax. It would tax imputed income and tax all appreciation.
-Proponents of the consumption tax base believe that it is neither appropriate nor desirable to tax savings, b/c it results in double taxation of savings, which is unfair and inefficient, and b/c a consumption tax is far easier to implement and administer than a normative income tax.
We don’t use H-S b/c its too pure, its not realistic. E.g. all imputed income would be taxed, otherwise it would be a tax expenditure. And labeling too many things as TEs would lessen the value of the word. Our system is more flexible than H-S, b/c it allows us not to tax imputed income and allows us to defer taxation, etc.
2. Consumption tax: just tax consumption: taxes total income minus savings. (our income = consumption + accumulation). TPs calculate income & savings, and what was left over would be taxed. Advantage: if you save, you put off taxation.