Federal Income Tax Outline

Federal Income Tax Fall 2016
Professor Newman
 
INTRODUCTION TO TAX
Nuts and Bolts
Considerations for a Tax Question:
(1) Is there income?
(2) Is there a deduction or a credit?
(3) If the answer to either of the above is yes:
(a) To whom?
(b) When?
(c) How is it characterized?
Basics of Tax Computation:
Add up your income
Subtract your deduction
Multiply the net amount by the appropriate tax rate, or consult the Tax Table
Subtract your tax credits and any tax you have already paid through withholding.
If you still owe, pay it. If you have overpaid, get a refund.
Authority
Constitution
Article I, Section 8 grants Congress the power to levy taxes
Amendment XIV grants Congress the power to collect income taxes
Cannot violate the EPC
Cannot take property through taxation without due process
Statutes
1986 Tax Reform Act was most significant tax legislation in recent years
Regulations
Promulgated by the Treasury Authority
Usually takes three years after the enactment of a statute before the Treasury promulgates a regulation
Cases
Tax Court opinions are appealable to the circuit in which the taxpayer resided at the time the Tax Court petition was filed.
Rulings
Private Letter Rulings
Write to IRS describing situation; IRS responds with how the situation would be taxed. Binding on the IRS, but only on the specific matter.
Public Revenue Rulings
If the IRS receives a substantial number of ruling requests on a similar issue, or if IRS for other reasons thinks that a certain issue is of more general interest, it will issue a public Revenue Ruling.
Basic Policy Choices: How to Finance Government Expenditures
Three Ways to Pay for Government Spending
(1) Print money
Results in inflation
(2) Borrow money
Interest rates are driven up when the government borrows money
Prices tend to follow the increase in interest rates
(3) Tax
The burdens of taxation, unlike inflation, can be allocated more effectively and more fairly than the burdens of inflation
Tax Options
Head Tax
Divide the total amount spent by the number of individuals (“heads”) and require each person to pay for a completely equal share.
Not everyone can afford to pay the same amount and some people can afford to pay more. Requiring each to pay the same regardless violates our notions of fairness.
Benefits Tax
Tax people based on the amount of benefits received from the government
BUT, the people who receive the most benefits are often those who are the least able to work/care for themselves/pay higher taxes.
Ability to Pay
Those who are able to pay more should pay more.
Ability to pay can be measured by income, spending, or wealth.
Taxing Spending
Haig-Simons Definition of Income
Income = Spending + Savings
Spending = Income – Savings
If we taxed spending then people would be encouraged to save money. This is good. BUT, poor people often need to spend all of their money. Therefore, a spending tax would favor the wealthier and impose a burden on poor people. This is called regressivity.
Wealth
Wealth may be taxes in terms of (1) having wealth, (2) getting wealth, or (3) giving wealth.
The problem with this, however, is that Americans tend to actually own very little.
Progressive Rates vs. Flat Rates
When taxes are described as flat or proportional, progressive, or regressive, what is being described is the relationship between the tax base and the tax rates.
Flat Rate (ProportionalTax)
All taxpayers pay the same percentage of their income.
Progressive Tax
Those with higher income pay not only more dollars, but a higher percentage as well.
The “marginal rate” – the rate on the last dollar of income – would rise with income.
Example:
If you are in the 30% tax bracket, the first X of dollars would be taxed at 10%, the amount in the Y bracket would be taxed at 20%, and the remaining X amount would be taxed at 30%.
The “effective rate” is computed by dividing the tax bill by the income.
Progressive tax rates help even out the distribution of wealth
Regressive Tax
Higher income taxpayers would pay a lower rate of tax than lower income taxpayers
How Tax Distorts Behavior
Credits are subtracted after your tax rate is applied; so a dollar is a dollar no matter where you fall. They benefit everyone equally
Deductions are subtracted before tax rate is applied; so a dollar saves a wealthier person more than a poorer person. They change behavior and affect people in different tax brackets differently.
If high-bracket taxpayers need a break; use deductions. If everyone needs a break; use credits.
Generally, it is best to create a tax code that still will make people do exactly what they want; and not distort their behavior.
Changing peoples’ behavior may lead to diminution of welfare and decline in efficiency of marketplace.
Policy Analysis of Tax Provisions
Ask the Following Questions:
Does it achieve horizontal equity?
Horizontal equity stands for the proposition that people in similar circumstances should be taxed in similar ways.
When analyzing an income tax provision, the most important similar circumstance is income level
Which circumstances other than income level justify differential tax treatment?
Does it achieve vertical equity?
Vertical equity invites an inquiry into the impact of the tax provision on different income levels.
Should the taxes be progressive, flat, or regressive?
Next, consider how the tax provision impacts differently upon various income levels, and determine whether or not it conforms to notion of vertical equity.
What economic impact would it have?
A tax increase takes more money from taxpayers and puts it into