Question

Taxation in America is always a "hot topic." In designing a taxation system

a. what are the basic principles to be considered?

b. how is the burden of a tax calculated?

c. list the three basic tax burdens (Hint: one of them is "progressive.") and list examples of each.

d. if the government creates a tax on wealth that taxes the first $50,000 of assets a person owns at 1%, the next $50,000 at 2%, the third at 3% and so on, what type of tax burden is that? How much tax would you owe if you had $125,000 in assets (car, personal property and small home)?

Answer 1

Part A: In designing a taxation system what are the basic principles to be considered?

In designing a taxation system the basic principles to be considered by a government includes:

• Adequacy: taxes should be just-enough to generate revenue required for provision of essential public services.
• Broad Basing: taxes should be spread over as wide as possible section of the population, or sectors of economy, to minimize the individual tax burden.
• Compatibility: taxes should be coordinated to ensure tax neutrality and overall objectives of good governance.
• Convenience: taxes should be enforced in a manner that facilitates voluntary compliance to the maximum extent possible.
• Earmarking: tax revenue from a specific source should be dedicated to a specific purpose only when there is a direct cost-and-benefit link between the tax source and the expenditure, such as use of motor fuel tax for road maintenance.
• Efficiency: tax collection efforts should not cost an inordinately high percentage of tax revenues.
• Equity: taxes should equally burden all individuals or entities in similar economic circumstances.
• Neutrality: taxes should not favour any one group or sector over another, and should not be designed to interfere-with or influence individual decisions-making.
• Predictability: collection of taxes should reinforce their inevitability and regularity.
• Restricted exemptions: tax exemptions must only be for specific purposes (such as to encourage investment) and for a limited period.
• Simplicity: tax assessment and determination should be easy to understand by an average taxpayer.

Part B: How is the burden of taxation calculated?

The burden of taxation can be measured in two ways:

1. First, it can be calculated as a cash payment--in much the same way that payments for ordinary goods are calculated.
   1. This is the most widely used measure by macro-economists, accountants, and newspaper reporters.
   2. It is also used in many international comparisons of income tax and VAT tax rates.
   3. However, it turns out that the burden of a tax is not always mainly borne by the person who "writes that check" to pay it.
2. Second, it can be calculated by determining the losses imposed on taxpayers as a consequence of the tax--that is to say the opportunity cost of the tax.
   1. That is to say, the burden of an excise or income tax can be measured as the reduction of consumer surplus and profits induced by the tax.
   2. This measure of burden is the most widely used among micro economists and public economists.
   3. This differs a bit from the money paid to the government, because the existence of a tax often reduces the extent of market transactions.
   4. That is to say, most taxes have a deadweight loss, which can be measured as the extent to which "social surplus" is reduced by the existence of a particular tax.

The advantage of calculating the total burden of a tax as the change in surplus generated by that tax rather than tax payments is that tax payments are often made by persons or firms who are little affected by a given tax.

1. For example, sales taxes are paid by firms in the sense that firms (or firm owners) actually write the checks deposited in the government's treasury. Thus, calculated as cash payments, one could say that the burden of a sales tax falls entirely on firms.
2. On the other hand, if firms simply increase their prices to pay for the tax, which is what they appear to do at the cash register, then the tax burden has really been "shifted" forward onto their customers, even though consumers never actually write checks for sales taxes and send them into the treasury.
3. In many cases, the persons most affected by a tax are not always the persons who "directly" pay the taxes by writing out a check to the treasury or IRS!

Part C: List the Three Basic Tax Burdens?

Tax systems fall into three main categories within the tax code: regressive, proportional and progressive taxes.

1. Regressive taxes: a regressive tax is the one in which tax rate decreases as the amount subject to taxation increases; and the tax rate progresses from high to low. The lowest amount is subject to higher taxation and this leads to individuals with low income bear the highest burden of regressive taxes. Such tax does not take into account the ability to pay. Indirect taxes, such as sales / service tax, are an example of regressive tax as the poor and rich pay the same tax in purchasing everyday products and services. Apart from indirect taxes, some other regressive tax examples are sin tax (tax on intoxicants such as tobacco and alcohol, which are more consumed by lower classes); toll tax (every passing vehicle of same type has to pay irrespective of income of the person travelling in that vehicle) etc.
2. Proportional tax: In this system, a flat tax is levied regardless of income of wealth. One example of corporation tax in India whereby government charges a flat rate of 30% on the income earned by the companies in India.
3. Progressive tax: In progressive taxation, the tax liability increases with individual or entity income. This is based on principle of “ability to pay”. Under this system, lowest income people are generally exempted while highest income people pay highest taxes. Income Tax is thus an example of progressive tax. Progressive taxation results in redistribution of income from rich to poor.

The U.S. federal tax system and local and state tax systems use all three types to collect tax revenue.

Part D: if the government creates a tax on wealth that taxes the first $50,000 of assets a person owns at 1%, the next $50,000 at 2%, the third at 3% and so on, what type of tax burden is that? How much tax would you owe if you had $125,000 in assets (car, personal property and small home)?

This is an example of progressive tax. The amount of tax paid is shown in the below table.

Inome Slab	Taxable Amount	Tax Rate	Income Tax
50000	50,000	1%	500
50000 - 100000	50,000	2%	1000
10000 - 1,50000	25,000	3%	750
Net Tax to be paid			2250