Wrapping up taxation Today: Studying taxation graphically The US Personal Income Tax The marriage penalty.

Wrapping up taxation

Today: Studying taxation graphically

The US Personal Income Tax

The marriage penalty

Problem 1a

OH

OM

.8

.6

$

16,000

18,000

DM

DH

Note that shares are on the vertical axis, and that the upward-sloping line has a vertical intercept of 0.6 relative to OH. Full credit required that the intercepts were properly labeled.

Megan’s share is 0.8 – Q/20,000 and Haley’s share is 0.6 – Q/30,000.

Problem 5b

Bjorn has just broken his hip and will require a trip to the hospital

The total cost of being in the hospital is 20,000Q; his total benefit of being in the hospital is 100,000Q – 5,000Q2

How long will Bjorn want to stay in the hospital if he must pay a $60,000 co-payment for his hospital stay? Note that MB of 1st day is higher than his co-payment

Bjorn will decide to enter the hospital After the co-payment is made, Bjorn’s MC is zero Set Bjorn’s MC equal to his MB

0 = 100,000 – 10,000Q Q = 10

Problem 6b

Assume that you work 40 hours per week, and that your hourly wage is $8 per hour

U(H,E) = HE4

Each unemployed person receives $100 per week in public health care; for the first $400 earned, $0.25 in public health care is lost for each dollar earned Thus, for anybody earning more than $400, no

public health care funds are received.

Problem 6b

For someone unemployed, only $100 in public health care is consumed; for the first 40 hours worked, the person earns $8 but loses $2 in public health care Net gain per hour worked is $6 Thus, working 40 hours leads to total

consumption of $100 + $6 * 40 = $340. Then, solve the same way as in part (a),

except use $340 instead of $320: E = $272, H = $68

Changes in consumption due to taxes Recall that people typically consume less of a

good or service once it is taxed Example: Yacht tax in the early 1990s

Tax on yachts over $100,000 purchased in the US People bought yachts in other countries Net economic impact

$16.6 million in taxes collected (less than the $31 million predicted)

Less income tax paid by workers (7,600 jobs lost in the US)

Study of taxation graphically Individual behavior Excess burden in a market with horizontal

supply Taxes on labor Subsidies Pigouvian taxes

How do taxes affect individual behavior?

Pou

nds

of c

orn

per

year

Pounds of barley per year

E1

B1

C1

DF

A

Cb

Ca

B0

E2

iii

G

Market excess burden, horizontal supply

Pounds of barley per year

Pric

e pe

r po

und

of b

arle

y

a

Db

Sb

q1q2

ih

S’b

Pb

(1 + tb)Pb g f

d

Tax revenues

Excess burden of tax

Remember: Excess burden and deadweight loss mean the same thing

Taxing labor

Hours per year

Wag

e ra

te p

er h

our

SL

L1L2

a

g(1 – t)w

wf i

h

Excess burden

d

Subsidies lead to excess burden, too

Housing services per year

Pric

e pe

r un

it o

f h

ousi

ng s

ervi

ces

m

Dh

Sh’

h2h1

uq

Sh

(1 – s)Ph

Ph

n o

r

Excess burden

v

Recall: Pigouvian taxes reduce excess burden

Q per year

$

MB

0

MD

MPC

MSC = MPC + MD

Q1Q*

c

d

(MPC + cd)

Pigouviantax revenues

i

j

Recall double dividend hypothesis Industry with negative externality

Pigouvian tax Reduces excess burden If tax proceeds are used to reduce other

taxes, excess burden from these taxes are lowered

Criticism: An environmental tax could lead to an increase in the excess burden in the labor market

An economist’s analysis

Given an amount of revenue that is generated, taxes should be imposed such that one of the following goals is achieved Excess burden is minimized Social welfare is maximized

The real world

Taxes are often imposed that have the lowest amount of political resistance

Excess burden seems less important than revenue generation Sometimes efficiency is completely ignored

The US Personal Income Tax About 45% of federal revenues are generated

through personal income taxes Federal taxes are easy and simple to

understand, right?

Federal personal income tax liability

Digesting federal income tax liability Tax Base- “Above-the-line” deductions

Adjusted Gross Income

- Exemptions- Larger of standard deduction or itemized deductions

Taxable Income• tax rate

Tax liability before credits- Tax credits

Regular tax liability

Wages and compensation, interest, dividends, capital gain (or loss), business income (or

loss), pensions, farm income (or loss), rents, royalties, Social

Security benefits, etc.

Trade or business expenses, moving expenses, educator

expenses, self-employed health insurance premium

payments, student loan payments, tuition and fees,

alimony paid, etc.

Phase-out with income

Charitable contributions, home mortgage interest, state and

local taxes, medical expenses in excess of 7.5% of AGI,

casualty and theft losses, non-reimbursed employee

expenses; Phase out with income; Differs by filing status

Six ordinary rates (10%, 15%, 25%, 28%, 33%, 35%);

differs by filing status; special

rates for dividends and capital gains

Child tax, additional child tax, EITC, HOPE and Lifetime Learning,

electric vehicles, health coverage tax, adoption, mortgage interest, retirement savings contribution, child and dependent care credit,

credit for the elderly or the disabled, D.C. First-Time

homebuyer’s credit, etc.; Phase-out with income

Start over to determine AMT tax liability using AMT base. Pay tentative AMT liability in excess of regular tax liability

Pay tax or claim refund

Other features of the US tax system Exemptions

$3,300 per family member is 2006 Deductions

Standard deduction $5,150 per single filer in 2006 $10,300 per joint filer in 2006 Fixed amount, no documentation needed

Itemized deductions Unreimbursed medical expenses above 7.5% of AGI State and local income and property Taxes Certain interest expenses Charitable contributions

More on simplicity

The Tax Reform Act of 1986 (TRA86) tried to simplify the tax system Increased standard deduction

Fewer people needed to itemize deductions Personal exemption increased substantially Fewer

people needed to file tax returns

Since 1986 Tax laws became more complicated About 15,000 changes to the tax code

More on simplicity

Is the tax code too complex? Some support a flat income tax

Same tax rate to everyone and each component of income

No deductions Little room for personal exemptions and business

expenses Criticism of flat income tax

Move tax burden from rich to middle class

Marginal tax rates

Official Statutory Tax Rate Schedule (2006)

Single Returns Joint ReturnsTaxable Income Marginal

Tax RateTaxable Income Marginal

Tax Rate

$0-$7,550 10% $0-$15,100 10%

$7,550-$30,650 15 $15,100-$61,300 15

$30,650-$74,200 25 $61,300-$123,700 25

$74,200-$154,800 28 $123,700-$188,450 28

$154,800-$336,550 33 $188,450-$336,550 33

$336,550 and over 35 $336,550 and over 35

Source: http://www.irs.gov/formspubs/article/0,,id=150856,00.html

Marginal tax rates




Tax Rate

$0-$7,825 10% $0-$15,650 10%

$7,825-$31,850 15 $15,650-$63,700 15

$31,850-$77,100 25 $63,700-$128,500 25

$77,100-$160,850 28 $128,500-$195,850 28

$160,850-$349,700 33 $195,850-$349,700 33

$349,700 and over 35 $349,700 and over 35


Inflation issues

Notice that the ranges on the marginal tax rate tables increase from year to year About 3.5-4% from 2006-2007 tax years Increases account for inflation

Taxes are on real income, so to speak

Alternative minimum tax (AMT) Not adjusted for inflation More Americans are

subject to the AMT each year What used to be a policy on the rich, is now a

policy on many upper-middle income Americans

The marriage penalty

We examine the marriage issue further There are many reasons that people in the

United States decide not to marry Costly to divorce if the marriage does not work out

well Many low-income people may lose benefits

People receiving public assistance may lose qualification for these programs if they marry someone who is working

Tax burden may increase as a married couple than as if they lived together unmarried

Example of the marriage penalty: Taxes Suppose a simple case

Only taxable income determines taxes that have to be paid

See what happens to tax burden when some couples get married

Recall marginal tax rates, 2007




Tax Rate

$0-$7,825 10% $0-$15,650 10%

$7,825-$31,850 15 $15,650-$63,700 15

$31,850-$77,100 25 $63,700-$128,500 25

$77,100-$160,850 28 $128,500-$195,850 28

$160,850-$349,700 33 $195,850-$349,700 33

$349,700 and over 35 $349,700 and over 35


Example 1, single

Cameron has $80,000 in taxable income Tax burden: $16,510.75 total

10% of $7,825 15% of $24,025 25% of $45,250 28% of $2,900

Erin has $80,000 in taxable income Tax burden: $16,510.75 total

10% of $7,825 15% of $24,025 25% of $45,250 28% of $2,900


Single Returns Joint Returns

Taxable Income

Marginal Tax Rate

Taxable Income

Marginal Tax Rate

$0-$7,825 10% $0-$15,650 10%

$7,825-$31,850

15 $15,650-$63,700

15

$31,850-$77,100

25 $63,700-$128,500

25

$77,100-$160,850

28 $128,500-$195,850

28

$160,850-$349,700

33 $195,850-$349,700

33

$349,700 and over

35 $349,700 and over

35

As single people, Cameron and Erin pay a total of $33,021.50 in taxes

Example 1, married

Cameron and Erin get married

Total taxable income is $160,000 Tax burden: $33,792.50

total 10% of $15,650 15% of $48,050 25% of $64,800 28% of $31,500 $771 more than the total

paid if they are single



Taxable Income

Marginal Tax Rate

Taxable Income

Marginal Tax Rate

$0-$7,825 10% $0-$15,650 10%

$7,825-$31,850

15 $15,650-$63,700

15

$31,850-$77,100

25 $63,700-$128,500

25

$77,100-$160,850

28 $128,500-$195,850

28

$160,850-$349,700

33 $195,850-$349,700

33

$349,700 and over

35 $349,700 and over

35

Example 2, single

Pat has $30,000 in taxable income Tax burden: $4,108.75 total

10% of $7,825 15% of $22,175

Shannon has $200,000 in taxable income Tax burden: $52,068.25

total 10% of $7,825 15% of $24,025 25% of $45,250 28% of $83,750 33% of $39,150



Taxable Income

Marginal Tax Rate

Taxable Income

Marginal Tax Rate

$0-$7,825 10% $0-$15,650 10%

$7,825-$31,850

15 $15,650-$63,700

15

$31,850-$77,100

25 $63,700-$128,500

25

$77,100-$160,850

28 $128,500-$195,850

28

$160,850-$349,700

33 $195,850-$349,700

33

$349,700 and over

35 $349,700 and over

35

As single people, Pat and Shannon pay a total of $56,177 in taxes

Example 2, married

Pat and Shannon get married

Total taxable income is $230,000 Tax burden: $55,100 total

10% of $15,650 15% of $48,050 25% of $64,800 28% of $67,350 33% of $34,150 $1,077 less than the total

paid if they are single



Taxable Income

Marginal Tax Rate

Taxable Income

Marginal Tax Rate

$0-$7,825 10% $0-$15,650 10%

$7,825-$31,850

15 $15,650-$63,700

15

$31,850-$77,100

25 $63,700-$128,500

25

$77,100-$160,850

28 $128,500-$195,850

28

$160,850-$349,700

33 $195,850-$349,700

33

$349,700 and over

35 $349,700 and over

35

Why the difference?

Look at marginal tax rates and the cut-offs

Example 1: Cameron/Erin, $80K each




Tax Rate

$0-$7,825 10% $0-$15,650 10%

$7,825-$31,850 15 $15,650-$63,700 15

$31,850-$77,100 25 $63,700-$128,500 25

$77,100-$160,850 28 $128,500-$195,850 28

$160,850-$349,700 33 $195,850-$349,700 33

$349,700 and over 35 $349,700 and over 35

More income is taxed in the 28% bracket after they get married

Example 2: Pat $30K/Shannon $200K




Tax Rate

$0-$7,825 10% $0-$15,650 10%

$7,825-$31,850 15 $15,650-$63,700 15

$31,850-$77,100 25 $63,700-$128,500 25

$77,100-$160,850 28 $128,500-$195,850 28

$160,850-$349,700 33 $195,850-$349,700 33

$349,700 and over 35 $349,700 and over 35

As a married couple, less income is taxed in the 28% and 33% brackets; more in the 25% bracket

Two reasons that this happens When there is one person

that earns almost all of the income, more money is usually subject to the lower marginal rates Notice that the two lowest

brackets vary by a factor of two

At the higher brackets, the income ranges converge Notice that the 35% bracket

is the same whether or not you are married



Taxable Income

Marginal Tax Rate

Taxable Income

Marginal Tax Rate

$0-$7,825 10% $0-$15,650 10%

$7,825-$31,850

15 $15,650-$63,700

15

$31,850-$77,100

25 $63,700-$128,500

25

$77,100-$160,850

28 $128,500-$195,850

28

$160,850-$349,700

33 $195,850-$349,700

33

$349,700 and over

35 $349,700 and over

35

Wrapping up taxation Today: Studying taxation graphically The US Personal Income Tax The marriage penalty.

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