Chapter 2 - Policy Standards for a Good Tax Flashcards
Define Tax Policy
The government’s attitude, objectives, and actions with respect to its tax system.
How does keeping up with tax policy issues help business managers?
By paying close attention to the current policy debate, managers can anticipate developments that might affect their firm’s long term strategies. Their familiarity with policy issues helps them assess the probability of changes in the tax law and develop contingent strategies to deal with such changes.
What are the basic standards every tax can and should be evaluated by? 4
- A good tax should be sufficient to raise the necessary government revenues.
- A good tax should be convenient for the government to administer and for people to pay.
- A good tax should be efficient in economic terms.
- A good tax should be fair.
When is a tax sufficient?
When it generates enough funds to pay for the public goods and services provided by the government. When it is sufficient a government can balance its budget.
What are three ways taxing jurisdictions can increase revenues?
- Exploit a new tax base (add income tax where there is none or increase income amount SS is taxed on)
- Increase rate of existing tax -
- Enlarge an existing tax base (expand what goods are taxed)
Which method of increasing tax revenue do taxing authorities use the most?
Base expansion method
What is Static Forecasting?
The assumption that an incase in the rate should increase government revenues by a proportional amount. The forecast is static because it assumes that the base variable, is independent of the rate variable. Accordingly, a change in the rate has no effect on the tax base.
Ex. Is the tax rate is 5% and the base is $500,00, a rate increase of 1% should generate $5,000 in additional taxes.
What is Dynamic Forecasting?
The prediction attempting to find out the extent to which a change in tax rates will affect the tax base and can incorporate the effect into its revenue projections. The basic assumption being that the variables of tax base and rate are correlated and not independent.
In the case of income tax, what does the incremental revenue generated by a rate increase depend on?
Whether, and to what extent, the increase affects the aggregate amount of income subject to tax. Specially, the increment depends on the ways that individuals modify their economic behavior in response to higher tax rates.
What is the Income Effect?
When an increase in income tax rates might induce people to engage in more income-producing activities to make up for the reduction in aftertax income. If this happens, the the government will enjoy a revenue windfall.
What is the Substitution Effect?
When an increase in income tax rates might induce people to devote less time and effort to their income-producing activity. This reaction makes sense if the after-tax value of an hour of additional labor is now worth less to someone than an additional hour of leisure.
Which type of people are likely to use the Income Effect? The Substitution Effect?
The people that use the income effect are those that are having trouble getting by, living paycheck to paycheck.
The people that use the substitution effect are those that have the luxury to reduce the amount of time spent at work, meaning they can still pay all their bills.
Why would the substitution effect make some jurisdictions wary about increase the tax rate on higher income earners?
They fear the high income earners will work so much less that there is no net increase in tax revenue collected.
What theory has its foundation in the substitution effect?
Supply-side economic theory.
What is the supply-side economic theory?
When a decrease in the highest income tax rates should ultimately result in an increase in government revenues. Accordingly, people who benefit directly from rate reduction will invest their tax windfall in new commercial ventures rather than simply spend it. This influx of private capital will stimulate economic growth and job creation.
From the government’s viewpoint, when is a tax convenient?
When it is easy to administer. Specifically, the government should have a method for collecting the tax that most taxpayers understand and with which they routinely cooperate.
It should be economical for the government. The administrative cost of collecting and enforcing the tax should be reasonable in comparison with the total revenue generated.
From the government’s view what is a type of tax that is convenient? Which is not?
Sales taxes are convenient.
Use taxes are not because the government has yet to develop a workable collection mechanism for them, therefore they generate almost no revenue.
When is a tax convenient for a taxpayer?
When it is convenient to pay. This suggests that people can compute their tax with reasonable certainty. Moreover they do not have to devote undue time or incur undue costs when complying with the tax law.
From the taxpayers view, what type of tax is convenient, which is not?
Sales tax is convenient. Easy to calculate and pay.
Income tax is uncertain and costly.
When is a tax considered economically efficient?
-A tax that does not interfere with or influence taxpayers economic behavior,
or
-When individuals and organizations react to the tax by deliberately changing their economic behavior.
Theoretically, what does the Classical standard of tax efficiency do?
Creates a level playing field on which individuals and organizations, operating in their own self interest, freely compete. When governments interfere with the system by taxing certain economic activities, the playing field tilts against the competitors engaging in those activities. The capitalistic game is disrupted, and the outcome may no longer be best for society.
Why, in line with the classical standard of tax efficiency, might economists conclude that “an old tax is a good tax”?
Because every time the government changes its tax structure, the contours of the economic playing field shift, and these are both costly and unsettling to the business community.
