ECON 1100 Global Economics (Fall 2013) The Distribution Function of Government portions for Exam 4 Relevant Readings from the Required Textbooks: Economics Chapter 12, Income Distribution and Poverty Problems from the Economics Textbook: Chapter 12 Problems (Pages 204-205): 7 Definitions and Concepts: Social Security System a system of Federal Government social insurance programs consisting of Old Age and Survivors Insurance pays cash benefits to retired workers, their survivors, and their dependents Disability Insurance pays cash benefits to disabled workers and their dependents Medicare program which provides medical insurance to people who are over age 65 or disabled Temporary Assistance for Needy Families a welfare program that provides cash benefits to low income households Supplemental Security Income a welfare program which provides cash benefits to poor elderly people with very low entitlements under traditional Social Security Unemployment Compensation a state government program that pays cash benefits to laid-off workers Medicaid a welfare program which provides medical care for people with low incomes Food Stamps vouchers (with a face value greater than their cost) available to low income families which can be used to purchase food at grocery stores Public Housing federal government program that provides access to housing with rents capped at 30% of income Earned Income Tax Credit a refundable Federal Income Tax Credit available to low income families with children (i.e., some people who pay no income taxes end up getting a check back from the IRS) three primary reasons for imposing taxes: generate revenue, discourage certain behaviors, redistribute income two basic notions of tax fairness or equity : Horizontal Equity two individuals of equal economic capacity should have equal tax burdens Vertical Equity individuals of greater economic capacity should not have a smaller tax burden Average Tax Rate (ATR) the amount of total taxes paid divided by income. Progressive Tax tax structure for which ATR increases as the level of income is increased.
Proportional Tax tax structure for which ATR remains constant as the level of income is increased. Regressive Tax tax structure for which ATR decreases as the level of income is increased. Marginal Tax Rate (MTR) the percentage of the next dollar earned that must be paid in taxes. real world examples of progressive tax: U.S. Federal Income Tax proportional tax: flat tax with no deductions whatsoever (e.g., flat tax proposed by Steve Forbes in 1996 was NOT a proportional tax, since the first $33,000 of earnings were not taxed; income taxes in Albania (10%), Bulgaria (10%), Czech Republic (15%), Iraq (15%), Jamaica (25%), Hong Kong (16%), Mongolia (10%), Russia (13%), Slovakia (19%), Ukraine (15%)) regressive tax: U.S. Social Security Payroll Tax first $102,000 taxed at a marginal rate of 6.2%, while additional earnings are not taxed at all
Overview of history of and current outcomes from the U.S. Federal Income Tax: 16 th Amendment to the U.S. Constitution ratified on 2/3/1913 authorized congress to levy an income tax U.S. Federal Income Tax established in 1913 Progressive Tax (increasing MTR) Primary source of U.S. Government tax receipts (I) Historical Tax Rates ( married couple filing jointly ) Year: # of Brackets: Low MTR: High MTR: 1913 7 brackets 1.0% 7.0% 1921 56 brackets 4.0% 73.0% 1928 23 brackets 1.5% 25.0% 1932 55 brackets 4.0% 63.0% 1941 32 brackets 10.0% 81.0% 1945 24 brackets 23.0% 94.0% 1954 24 brackets 20.0% 91.0% 1964 26 brackets 16.0% 77.0% 1980 16 brackets 0% 70.0% 1992 3 brackets 15.0% 31.0% 2000 5 brackets 15.0% 39.6% 2002 6 brackets 10.0% 35.0% 2013 7 brackets 10.0% 39.6% (in reality the effective Low MTR has always been 0%, due to the presence of exemptions and deductions) (II.A) Disproportionate amount of tax dollars come from The Rich Group s Group s % Range Income Share of Share of of Income Split Income Taxes Income Top 1% $343,927+ 36.7% 16.9% Top 5% $154,643+ 58.7% 31.7% Top 10% $112,124+ 70.5% 43.2% Top 25% $66,193+ 87.3% 65.8% Top 50% $32,396+ 97.7% 86.5% Top 5% pay 58.7% of all income tax dollars => Bottom 95% pay 41.3% Top 10% pay 70.5% of all income tax dollars => Bottom 90% pay 29.5% Top 1% pay more income taxes than the Bottom 90% (36.7% versus 29.5%) Top 1% pay almost as much in income taxes as the Bottom 95% (36.7% versus 41.3%) Top 50% pay 97.7% of all income tax dollars => Bottom 50% only pay 2.3% 137.98 million tax returns with positive AGI. Of these, 59 million (or 42.76% of the filed returns) had federal income tax liability of $0 => people who not only got back every single dollar the Federal government withheld, but in some cases received money back from the IRS (recall the EITC)
(II.B) U.S. Federal Income Tax is clearly progressive % Range Average of Income Tax Rate Top 1% 24.01% Top 2%-5% 16.4% Top 6%-10% 11.4% Top 11%-25% 8.25% Top 26%-50% 5.56% Bottom 50% 1.85% (II.C) Across income levels, ATR has evolved over time Top 1% Top 11-25% Top 26-50% Bottom 50% 1980 34.47% 14.80% 11.91% 6.10% 1988 24.04% 11.82% 9.60% 5.06% 1992 25.05% 11.39% 9.42% 4.39% 2000 27.45% 12.04% 9.28% 4.60% 2008 23.27% 9.29% 6.75% 2.59% 2009 24.01% 8.25% 5.56% 1.85% Between 2000 and 2009: ATR of every income group decreased % decrease in ATR: o 12.53% ([27.45 24.01]/[27.45]) decrease in ATR for Top 1% o 31.48% decrease in ATR for Top 11-25% o 40.09% decrease in ATR for Top 26-50% o 59.78% decrease in ATR for Bottom 50%
Problems: 1. The country of Roncoazakhstan has just enacted an income tax as follows. For each of the first 100,000 CoaseMarks (their national currency) earned a worker does not have to pay any taxes; for each CoaseMark earned beyond the 100,000 th and 200,000 th a worker must pay 10% to the government; and for each CoaseMark earned beyond the 200,000 th a worker must pay 20% to the government. 1A. Without doing any calculations, is this tax Regressive, Proportional, or Progressive? Explain. 1B. Adam earns 150,000 CoaseMarks per year. How much must he pay in taxes? What is his Average Tax Rate? What Marginal Tax Rate does he face? 1C. Smith earns 400,000 CoaseMarks per year. How much must he pay in taxes? What is his Average Tax Rate? What Marginal Tax Rate does he face? 1D. Are your answers to parts (A), (B), (C), and (D) consistent with or inconsistent with one another? Explain.
Multiple Choice Questions: 2. Under the current U.S. Federal Income Tax, the Top 1% of wage earners pay A. about 36.7% of all taxes collected, an amount which is greater than the 29.5% of all taxes collected paid by the bottom 90% of wage earners. B. about 16.9% of all taxes collected, an amount exactly equal to their share of total adjusted gross income earned. C. about 14.8% of all taxes collected, an amount which is slightly less than their share of total adjusted gross income (which is 16.9% of total adjusted gross income). D. virtually no taxes, due to all of the loopholes in the current tax code. 7. The U.S. Federal Income Tax A. was first established in 1913 (and authorized by the passage of the 16 th Amendment to the U.S. Constitution). B. is a Progressive Tax. C. was abolished by President Barack Obama during his first year in office. D. More than one (perhaps all) of the above answers is correct. 9. In 2007: George earned $923,807 of income, of which he paid 24.0% in U.S. Federal Income Taxes; John earned $386,527 of income, of which he paid 30.7% in U.S. Federal Income Taxes; and Joe earned $319,853, of which he paid 20.7% in U.S. Federal Income Taxes. If income provides a measure of economic capacity and average tax rate provides a measure of tax burden, then these figures would suggest that the U.S. Federal Income Tax A. violates the notion of vertical equity. B. satisfies the notion of horizontal equity. C. generates enough revenue to cover all Federal Government expenditures. D. results in the rich paying too little in taxes. 11. says that in order for a tax to be fair, two individuals of equal economic capacity should have equal tax burdens. A. John Rawls B. The notion of vertical equity C. The notion of horizontal equity D. The notion of monetary equity 14. Which of the following countries currently has a progressive income tax? A. The Czech Republic. B. The United States. C. Iraq. D. More than one (perhaps all) of the above answers is correct.
17. Focusing on the benefits provided through the Temporary Assistance for Needy Families (TANF) welfare program, the maximum monthly payment to a oneparent family of three in January 2003 A. was $500 in every single state in the U.S. B. was $0 in every single state in the U.S. (due to this program being abolished by George W. Bush on his first day as President). C. varied by state (due to benefit levels being set by each state) from a low of $170 in Mississippi to a high of $923 in Alaska. D. None of the above answers are correct. 18. Focusing on the Average Tax Rate of the Bottom 50% of Income Earners, this figure between 1980 and 2000 and then between 2000 and 2009. A. increased from 2.34% up to 3.78%; increased more from 3.78% up to 4.95% B. decreased from 6.10% down to 4.60%; decreased more from 4.60% down to 1.85% C. decreased from 11.91% down to 3.60%; increased from 3.60% up to 7.36% D. remained constant at 12.17%; sharply increased to 21.43% 19. Consider three taxpayers: Amy, Bill, and Cindy. Amy and Bill have exactly equal economic capacities when it comes to being able to bear the burden of taxation, while Cindy has a greater economic capacity than Amy and Bill. Considering the notions of fairness discussed in lecture, A. to satisfy the notion of Vertical Equity, Cindy should have a greater tax burden than both Amy and Bill. B. to satisfy the notion of Horizontal Equity, Cindy should have a greater tax burden than both Amy and Bill. C. to satisfy the notion of Horizontal Equity, Amy and Bill should have exactly equal tax burdens. D. More than one (perhaps all) of the above answers is correct. 22. is a welfare program which provides cash benefits to poor elderly people with very low entitlements under the traditional Social Security system. A. Temporary Assistance for Needy Families B. Medicaid C. Supplemental Security Income D. The Earned Income Tax Credit
23. In the United States, the highest Marginal Tax Rate currently imposed under the federal income tax is A. 17%, since every dollar earned by every worker in the U.S. is taxed by the federal government at a Marginal Rate of 17%. B. 39.6%, a highest Marginal Tax Rate which is lower than the highest Marginal Tax Rate of 70% which was in place in 1980 but higher than the highest Marginal Tax Rate of 35% which was in place in 2002. C. 83%, a rate so high that it caused Brian Johnson (the lead singer of AC/DC) to move from Hawai i to England to avoid having to pay such a large fraction of his income in taxes. D. 91%, the highest level that the highest Marginal Tax Rate has ever been in the history of our country. 25. Regarding the notions of fairness of taxation discussed in lecture, the idea of A. low income equity suggests that individuals with very low economic capacity should never be burdened with having to pay any taxes. B. horizontal equity suggests that individuals of equal economic capacity should have equal tax burdens. C. vertical equity suggests that individuals with greater economic capacity should have smaller tax burdens. D. political equity suggests that the only people who should have to pay taxes are those individuals who voted for the politicians implementing the taxes. 26. For a Regressive Tax A. the Average Tax Rate becomes negative at very high levels of income. B. the Average Tax Rate increases as the level of income increases. C. the Average Tax Rate decreases as the level of income increases. D. the Average Tax Rate remains constant as the level of income increases. Answers to Problems: 1A. A tax is progressive if the Average Tax Rate increases as income increases. Recalling the general relation between any average and the corresponding marginal, the Average will never decrease if the Marginal Value always increases as income increases. Thus, since the Marginal Tax Rate becomes higher at higher level of income, it follows that this tax is a Progressive Tax. 1B. Adam must pay 10% of the 50,000 CoaseMarks earned between 100,000 and 150,000. Thus, his total tax liability is 5,000 CoaseMarks. It follows that his Average Tax Rate is (5,000)/(150,000)=(1)/(30) or approximately 3.33%. His Marginal Tax Rate is 10%, since if he were to earn 1 more CoaseMark his total tax liability would increase by (.10) CoaseMarks. 1C. Smith must pay 10% of the 100,000 CoaseMarks earned between 100,000 and 200,000 and 20% of the 200,000 CoaseMarks earned between 200,000 and 400,000. Thus, his total tax liability is (.10)(100,000)+(.20)(200,000) = 50,000
CoaseMarks. It follows that his Average Tax Rate is (50,000)/(400,000)=12.5%. His Marginal Tax Rate is 20%, since if he were to earn 1 more CoaseMark his total tax liability would increase by (.20) CoaseMarks. 1D. Yes, the above answers are consistent with one another. From (1B) and (1C) we see that the individual with higher income has a higher ATR. This is consistent with the answer to part (1A), where it was noted that this tax is a progressive tax. Answers to Multiple Choice Questions: 1. C 2. A 3. C 4. B 5. D 6. B 7. D 8. C 9. A 10. C 11. C 12. C 13. D 14. B 15. C 16. B 17. C 18. B 19. D 20. A 21. B 22. C 23. B 24. C 25. B 26. C