Economics / Unit 9: Government, Taxes and Fiscal Policy
9.1 Principles and Structures of Taxation
Notes
Governments collect taxes to pay for public goods and services. The power to tax comes from the Constitution; the Sixteenth Amendment (1913) allowed a federal income tax.
- Benefits-received principle: people who benefit from a service pay for it (a gasoline tax funds roads). Ability-to-pay principle: people with more income or wealth pay more.
- Good taxes are often judged by equity (fairness), simplicity and efficiency (collecting revenue without distorting choices much).
- Tax structures compare the share of income paid:
| Structure | Share of income taken as income rises | Example |
|---|---|---|
| Progressive | rises | federal income tax |
| Proportional (flat) | stays the same | a flat $5\%$ income tax |
| Regressive | falls | sales taxes on everyday goods |
- Worked example: two families each spend $4,000 a year on goods taxed at $5\%$, paying $200 each. For a family earning $20,000, that is $1\%$ of income; for one earning $100,000, it is $0.2\%$. The tax takes a larger share of the lower income, so it is regressive.
- Tax incidence is who actually bears the burden. A tax on sellers may be partly passed on to buyers through higher prices.
Practice
A tax takes $10\%$ of income from people who earn $30,000 and $10\%$ from people who earn $300,000. This tax is:
The same percentage applies at every income level.
Highway tolls paid by drivers who use the highway follow which principle?
Those who use the road pay for it.
Why do economists often describe a sales tax on groceries as regressive?
The same rate on purchases is a bigger fraction of a smaller income.
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