Tax Midterm Outline – Schenk, Fall 2016
INTRO TO FEDERAL TAXATION
[HISTORY OF TAX IN THE USA]
= process by which a gov transfers resources (almost always money) from the private to the public sector
Need to upgrade resources, but ppl don’t want to pay= conflict
In deciding who, what and when to tax, congress makes fundamental social and economic judgments—affect economy and use of resources
Issues w/ public policy
Link btwn ppl & gov
Long resistance to taxes
Flat tax: (short for flat tax rate) is a tax system with a constant marginal rate, usually applied to individual or corporate income. A true flat tax would be a proportional tax, but implementations are often progressive and sometimes regressive depending on deductions and exemptions in the tax base.
There have been proposals of income tax at base rate
We have changed our view on where we should get our revenue from
It is really hard to find an area where tax does not play a role
This is the most imp class in law school
Goals of tax policies
Facilitate growth of nation’s economy
Do justice in the distribution of burdens and benefits of govt
Raise revenues adequate to finance govt’s expenditures
A. 20th Century: Expansion and Entrenchment of Income and Wage Taxes
: Congress enacted taxes on estates
: Congress enacted a tax on gifts
: Revenue Act of 1932 – meant to raise taxes to lower the deficit caused by the Depression – only prolonged the Depression
: Peacetime – Roosevelt proposed to reduce taxes on corporations and other businesses by accelerating deductions for depreciation
Followed by Eisenhower, Kennedy, Nixon, Reagan, and Gingrich
A low maximum tax rate is critical to the American economy
B. Extension of Income Tax to Most Americans
Originally, income tax was only applied to 400K people at low rates
During WWII, that changed and income tax was to be paid by most Americans**
WWII – income tax paid by most Americans – income tax rates reached their peak of 94% **
Lowered following WWII but raised again to fund Korean War
During Kennedy's presidency, use of tax policy as a short-term economic stimulus became commonplace
The civil war income tax
First income tax – Prez Lincoln, civil war time**
No income taxes b4 civil war
Legislation reducing income tax to stimulate economy:
Revenue Act of 1964; Revenue Act of 1971; Tax Reduction Act of 1975; Economic Recovery Tax act of 1981
Tax increases occurred to combat growing deficits in 1982, 1984, 1990, 1993
C. Tax Reform of 1986
Strengthen income tax rather than replace it with consumption tax
Repeal preferential rates on capital gains
Base broadening with lower rates.
Supposed to be the biggest tax change since income tax in WWII but ended up being only a slight improvement
Failed to produce a better tax system – lower rates were reinstated within several years and Congress raised rates and enacted new incentive provisions.
DID improve economic efficiency of investment decisions by removing or reducing certain tax provisions that had produced very unequal rates of tax on different investments
Politicians since 1986 like to suggest to repeal the income tax as their platform – hasn’t happened yet
1990 Act – Budget act meant to slow federal expenditures – tax increases
1993 Legislation – raised income taxes particularly on high income ppl
Economic growth and budget legislation –> converted deficits to surpluses in 1990s
[INTRO TO FEDERAL INCOME TAX]
A. Pillars of establishing a tax system
(1) Equity- requires a determination of what are “similar economic circumstances”
Horizontal equity- satisfied if those with equal incomes are taxed equally.
For a tax to be fair it should not impose significantly different burdens on those in similar economic circumstances
DO NOT have horizontal equity in the individual income tax
People with uneven incomes pay uneven taxes
people in the same circumstances should have the same tax burden*
People with same incomes should pay the same tax
Our tax system isn't great in this:
(1) b/c we make a distinction btwn married and unmarried taxpayers
We have diff rate schedules for the same amt of taxable income when married *
What is the reason for different rate schedules for married and unmarried??— it’s the idea of sharing, married individuals share their resources so we shouldn’t treat them as a single taxpayer
Why limit it only to the ppl who are married?? Lots of ppl share expenses and such
We want a simple system, ppl who are not married are fluid and change
(2) also distinction btwn. single parents and household w/ a dependents
If you have kids, you use the same rate schedule, but you get diff deductions
Vertical equity- USED IN THE USA – satisfied if taxpayers with unequal incomes are taxed unequally.
Those in unequal positions should pay unequal taxes. *
The higher your income, the more you have ability to pay, and therefore we should impose a higher tax burden
This concept supports progressive taxes- those with higher incomes should pay a higher percentage of tax.
Basis for the progressive individual income tax system
(2) Efficiency- in economic terms, as little interference as possible in peoples’ market behaviors. Business people should not be making decisions based on tax law.
tax interferes as little as possible w/ people’s economic behavior *
Almost all taxes have efficiency costs= non-neutral
When pillar of tax system supports one exon behavior over other= reduces efficiency
Another view is whether it affects economic growth (if yes, then it is efficient).
Tax system should not encourage tax payers to do one thing and not the other.BUT there is encouragement and distortion
Since some income isn’t taxed (ie: municipal bonds), the interest is excludable from income. So there are choices to make – if have money to invest, one of the distortions is that we treat municipal bond interest diff from interest on savings account in a bank.
We impose a lower top rate on capital gains than we do on labor income.
When choosing to put money in a CD or in a stock there is a distortion
System encourages certain types of consumption over others – ie: home ownership over rental. If itemize, can deductions for ownership over rental.
(3) Simplicity- the tax laws should be as simple as possible so that taxpayers can calculate their taxes, understand them and comply with them.
complex tax rules are inefficient b/c taxpayers m
igrating, or becoming poor, so the dead tax would have minimal impact in changing ppl's behavior
Avoids ppl's ability to pay
Benefit theory= tax based on how much ppl benefit from gov goods and services
All govs of world are financed by 3-4 taxes: income, wages, consumption, or wealth
US today= income and wage taxes are major sources of fed revenue (90%); consumption and wealth goes to state and local govs
4 tax bases are linked
Args for replacing consumption w/ income tax
Wealth taxes= imposed on capital accumulation
Or current federal income tax is part wage or consumption and part income tax
Based on equality and ability to pay
[BASIC TERMINOLOGY AND STRUCTURE OF THE IRS]
Income Tax = Taxable Income multiplied by the Tax Rate Minus any Credits
§ 1 Individual income tax is imposed on taxable income. Provides the rates for various categories of tax payers.
Taxable Income = Gross income minus Itemized Deductions
only take itemized deductions if greater than standard deductions, 2/3 do standard)
If itemized need provision in IRC that allows particular itemized deduction.
If you do not Itemize Deductions – Taxable Income = AGI minus (standard deduction + deduction of personal exemptions § 151)
§ 61 Defines Gross Income- all income from whatever source derived.
The list is illustrative, not exhaustive.
Includes: wages, commissions, compensation, dividends, alimony, lottery
Includes capital gains and losses from sale of stock, bonds, real estate, etc.
: amount realized minus basis
If Basis/Adjusted Basis exceeds the Sale Price
§ 62 Defines Adjusted Gross Income- gross income minus the following deductions.
NOTE – This section is only definitional – says what deductions are listed here but the actual rule is elsewhere.
An individual TP can take the deductions that are authorized by some substantive rule and listed under § 62 whether or not that person takes a standard deduction – i.e. take this deduction along with standard or itemized deduction.
Any item listed in §62is deductible in arriving at AGI.(ABOVE THE LINE)
Three categories for exclusion of certain aspects of income.
(2) Statutory (IRC)
Any item that is deductible when arriving at adjusted gross income is deductible, whether or not you itemize. Includes:
Trade or business deductions
Certain trade or business deductions of employees
Reimbursed expenses of employees
Certain expenses of performing artists
Certain expenses of officials
Certain expenses of elementary and secondary school teachers