🏙️Public Economics Unit 3 – Government Revenue and Taxation

What's This Unit All About?

• Explores the various ways governments generate revenue to fund public goods and services
• Examines the principles and theories behind taxation as a primary source of government revenue
• Analyzes the economic effects of different tax policies on individuals, businesses, and the overall economy
• Compares and contrasts various tax systems and structures employed by governments around the world
• Discusses current issues and debates surrounding taxation, such as tax reform, tax evasion, and international tax competition
• Applies economic concepts and theories to real-world examples of taxation and government revenue generation

Key Concepts and Definitions

• Public goods are non-excludable and non-rivalrous goods or services provided by the government (national defense, public parks)
  • Non-excludable means individuals cannot be effectively excluded from using the good or service
  • Non-rivalrous indicates that the consumption of the good or service by one individual does not reduce its availability to others
• Tax incidence refers to the division of the tax burden between buyers and sellers in a market
  • Statutory incidence is the legal obligation to pay the tax
  • Economic incidence is the actual burden of the tax, which may be shifted through changes in prices
• Marginal tax rate is the tax rate applied to the last dollar of income earned
• Progressive taxation imposes higher tax rates on higher income levels (income tax)
• Regressive taxation imposes higher tax rates on lower income levels (sales tax)
• Proportional taxation applies the same tax rate across all income levels (flat tax)
• Tax base is the total amount of income, property, or consumption subject to taxation

Types of Government Revenue

• Taxes are compulsory payments to the government without a direct benefit in return
  • Income taxes are levied on individual or corporate earnings
  • Consumption taxes are applied to the sale of goods and services (sales tax, value-added tax)
  • Property taxes are based on the value of owned assets (real estate, vehicles)
• Fees are charges for specific government services or privileges (driver's licenses, park entry)
• Fines and penalties are imposed for violations of laws or regulations (parking tickets, speeding fines)
• Government-owned enterprises generate revenue through the sale of goods or services (postal services, public utilities)
• Intergovernmental transfers are funds received from other levels of government (federal grants to states)
• Borrowing involves raising funds through the issuance of government bonds or securities

Principles of Taxation

• Equity and fairness ensure that taxpayers in similar circumstances pay similar amounts of taxes (horizontal equity) and that those with a greater ability to pay bear a larger tax burden (vertical equity)
• Efficiency minimizes the distortionary effects of taxes on economic behavior and decision-making
• Simplicity and transparency make tax systems easy to understand and comply with, reducing administrative costs and the potential for tax evasion
• Neutrality ensures that taxes do not unduly favor or disadvantage particular economic activities or sectors
• Adequacy and stability provide sufficient and predictable revenue to fund government expenditures over time
• Flexibility allows tax systems to adapt to changing economic conditions and policy objectives

Tax Systems and Structures

• Progressive tax systems impose higher tax rates on higher income levels (United States)
• Regressive tax systems place a greater tax burden on lower-income individuals (sales taxes)
• Proportional tax systems apply a single tax rate across all income levels (Russia)
• Direct taxes are levied directly on individuals or organizations (income tax, corporate tax)
• Indirect taxes are imposed on goods and services and collected by intermediaries (value-added tax, excise tax)
• Worldwide tax systems tax residents on their global income, regardless of where it is earned (United States)
• Territorial tax systems only tax income earned within the country's borders (Hong Kong)

Economic Effects of Taxation

• Taxes can create deadweight loss by distorting market prices and reducing economic efficiency
• High marginal tax rates may discourage work, saving, and investment, leading to reduced economic growth
• Tax incentives can be used to encourage specific behaviors or economic activities (renewable energy tax credits)
• The Laffer Curve suggests that increasing tax rates beyond a certain point may decrease total tax revenue due to reduced economic activity
• Taxes can affect the distribution of income and wealth, potentially reducing inequality (progressive taxation)
• International tax competition can lead to countries lowering tax rates to attract foreign investment and businesses

Current Issues and Debates

• Tax reform efforts seek to simplify tax systems, reduce tax rates, or shift the tax burden (2017 U.S. Tax Cuts and Jobs Act)
• Tax evasion and avoidance by individuals and corporations result in lost government revenue and increased tax burdens on compliant taxpayers (Panama Papers scandal)
• Digital taxation challenges arise from the difficulty of taxing online transactions and digital services across borders
• Carbon taxes and other environmental taxes aim to address negative externalities and promote sustainable practices
• Wealth taxes are proposed as a means to reduce income and wealth inequality (Elizabeth Warren's wealth tax proposal)
• The role of taxes in addressing social and economic issues, such as healthcare, education, and infrastructure, is a topic of ongoing debate

Real-World Applications

• The United States has a progressive income tax system with marginal tax rates ranging from 10% to 37% (as of 2021)
• Value-added taxes (VATs) are widely used in the European Union, with rates varying by country and product (standard VAT rate in Germany is 19%)
• The Earned Income Tax Credit (EITC) is a refundable tax credit in the United States that supports low-income working families
• Tax havens, such as the Cayman Islands and Bermuda, offer low or no taxes to attract foreign investment and businesses
• The Affordable Care Act (Obamacare) in the United States included tax provisions, such as the individual mandate penalty and the medical device tax
• Carbon taxes have been implemented in countries like Sweden and Canada to reduce greenhouse gas emissions and combat climate change