Ch 7: Income Taxes Flashcards
No capitation, or other direct, tax shall be laid, unless in proportion to the census or enumeration herein before directed to be taken.”
U.S. Constitution, Article I, Section 9
Also known as the Income Tax Act of 1894
Wilson-Gorman Tariff Act
* Reduced tariffs imposed by the McKinley tariff
* 2% tax on interest, dividends and rents above $4,000 (over $120,00 in 2020)
* Applied to less than 1% of pop.
* Created the Bureau of the Internal Revenue (now Internal Revenue Service)
1895—the Supreme Court’s decision in Pollock v. Farmers’ Loan & Trust Co.
found the Wilson-Gorman Tariff Act to be unconstitutional
1909—President William Howard Taft proposed
constitutional amendment to allow for an income tax
1913—The XVI Amendment ratified
allows the Congress to collect taxes on income—regardless of source
of income—without apportioning it among the states or basing it on census results
– Congress levied a 1% tax on incomes of more than $3,000, and a 6% tax on incomes of more than $500,000
* $3,000 in 1913 is equivalent in purchasing power to about $78,387.27 in 2020
* $500,000 in 1913 is equivalent in purchasing power to about $13,064,545 in 2020
– Introduced Form 1040 (the same basic form that is used today)
Equity
Income is an adequate ability-to-pay measure
– Income can be adjusted to fit taxpayer conditions
Yield
Adequate yield based on income
– Income (Tax) base positively related to economic conditions
Distortion
Economic decisions not markedly distorted because the tax base
(income) is large in scope
Disadvantages of taxing income
Lack of transparency and complicated
– Hard to comply with
– Tax loopholes
* Expensive to administer
– only when taxpayer cost is included
* Distorts economic choices
– Tax applies to interest earned
* Consumption is encouraged
– Unequal effective tax rates on capital investment
* Economic resources manipulated looking for tax advantages
* Equity
– Not progressive enough versus not proportional enough
– Too many loopholes allow some not to pay enough
* Overuse
– Compounds inequities and distortions because of the scope of use
xx% choose standard deductions
66%
Tax rates increase in steps as
income increases.
Marginal tax rate
the rate paid on the next dollar of income earned.
Tax deduction vs tax credit
While a tax deduction reduces your taxable income, a tax
credit reduces the amount of tax you owe the IRS.
Biggest anti-poverty program for low to moderate income individuals and families
Earned Income Tax Credit
* Maximum of $6,557 with three or more qualifying children
* $529 with no qualifying child
* Reaches zero as earnings pass $55,952 (married filing jointly/3+ children)
* The dollar amounts are indexed annually for inflation
Bracket Creep
Taxpayers pushed into a higher tax bracket without effectively making more money.
_____ removes the effect of bracket creep
Indexation
The federal income tax has indexed exemptions, standard
deductions, and bracket points since
1985
Corporate income tax applies to
total net earnings
Applies to both earning retained by the firm and those disbursed to
stockholders
Charitable contributions are deducted
Characteristics of payroll taxes
Narrow bases and exclude income more likely to be received by high-income individuals (dividends)
– People with similar incomes would pay different amounts based on the kind of income (dividend income is excluded)
– Social Security–As of 2019, the employer must withhold 6.2% of an employee’s wages (up to $132,900) and pay a matching amount.
– Self-employed individuals pay tax at a 12.4% rate up to the limit.
– Medicare–As of 2019, the employer must withhold 1.45% of an employee’s wages and must pay a matching amount—no max wage base as in SS taxes
Advantages of flat tax rate
– Simple and less expensive to administer
– Fair because everyone pays the same rate?
– It stimulates the economy by removing economic disincentives to invest,
which would help the poor?
* The poor would in turn pay more in taxes because their income would have gone up due
to more employment opportunities and better wages
Disadvantages of flat tax rate
Would be simple and less expensive to administer only if it were a true flat
tax rate (unrealistic)
– ‘Fair’ to the extent that there are no deductions for accumulated wealth,
capital losses, etc.
– Regressive—why?
These states have no state income tax on wages
New Hampshire and Tennessee
These states have no state income tax
Alaska, Florida, Nevada, South Dakota, Texas
