Personal income tax Flashcards
What are payroll taxes?
Tax withheld from an employee’s salary who transfers to the government. They are used to finance social security
What is individual income tax?
Tax paid by individuals on income accrued during the years
How is individual income tax different from payroll tax if they both include labor earnings?
Individual income tax applies to a broader set of income sources:
- Interest earnings from household savings
- Rent
- Capital gain
- It is sometimes applied to family income
What is tax vertical equity?
Groups with more resources should pay higher taxes. It is applied in relative terms (higher SHARE of the income)
What is tax horizontal equity?
Individuals who are similar, but make different economic lifestyle choices, should be treated the same by the tax system
What is the marginal tax rate?
Percentage of the next euro of taxable income that is paid in taxes. To put it simply, the tax applied on the last euro
What is the average tax rate?
Percentage of total income that is paid in taxes
What is the definition of progressive taxation?
As income increases, tax liability increases more than proportionally, avg tax rate increases with income
At any rate marginal tax > avg tax rate
What is a proportional/flat tax rate?
When all tax payers pay the same income SHARE
What type of tax is being applied when marginal tax > avg tax rate for any rate?
Progressive taxation
What type of tax is being applied when marginal tax < avg tax rate for any rate?
Flat rate
What is the definition of regressive taxation?
- Avg tax decreases with income
- Marginal tax rate < avg tax rate
What are the two ways we can achieve progressive taxation?
Income brackets and tax deductions
What are the two types of tax deductions?
1- An amount is subtracted from income BEFORE the tax rate is applied. The rate is constant
2- An amount is subtracted AFTER the tax rate is applied
Which method of tax deduction is more effective to achieve vertical equity and why?
An amount is subtracted AFTER the tax rate is applied
td-f
-Because “td” increases with income and individuals with lower incomes will benefit from higher deduction
-Sometimes f decreases with income
What is comprehensive income definition?
Total income = potential annual consumption, that is, the salary + any NET increase on the income. So tax is computed based on that
With tax deductions is personal income base higher or lower than comprehensive income?
Lower
Without tax deductions is personal income tax
base higher or lower than comprehensive income?
Higher
On what can deductibility be applied to?
Not desired consumption, costs of earning income (legitimate costs of doing business) and on activities that may produce positive externalities such as charity and home property
What is the best desirable system of taxes?
Progressivity
Horizontal equity among families
Horizontal wrt to marriage choices
But it is impossible to satisfy them all simultaneously
What are the pros of individual taxation?
Neutrality wrt marriage
Neutrality wrt labor supply choice
VERTICAL EQUITY but not horizontally
What are the cons of family-based taxation?
- Doesn’t guarantee horizontal equity wrt marriage
- Penalizes families with homogeneous return wrt heterogeneous
- Negatively influence labor supply of the lower income spouse bc it is subject to higher tax
What would be a solution to the family-base taxation?
Flat rate, but that would violate progressivity
