Taxes

Matt Lupo

Mrs. Straub

AP Econ

12 April 2015

Taxes

With the tax filing deadline approaching on April 15, taxes seemed like an appropriate – if boring – topic for an economics blog post. Taxes are a vital part of any economy because they provide almost all of the revenue raised by the government [see graph below (Williams)], and this revenue is then used to provide numerous public goods and pay the salaries of government employees, which Mike Patton of Forbes estimates to be about 7% of the population of the United States (Patton). The two main functions of taxes are to fund the government’s operations and to potentially reduce income inequality, but how well does the current tax system accomplish these goals?

Despite a minor budget surplus that spanned from 1998-2001 (at which time the U.S. entered into a recession), the federal government has run on a deficit for much of the last forty years (Fraser). Seemingly, this would imply that taxes are doing a poor job of funding the federal government, as the revenue raised insufficiently covers the government’s expenditures. However, there are a few factors that must be considered before this judgment can be accepted. Most importantly, we must evaluate the context of the deficits and the underlying economic theory behind these deficits. During the drastic spike in deficit spending, highlighted on the graph below (Fraser) as the period from 2009-2012, the United States was recovering from a recession. According to the popular Keynesian theory, changes in aggregate demand can be used to counter the effects of a recession (Jahan, Mahmud and Papageorgiou). In order to change the aggregate demand, the government must implement an expansionary fiscal policy, which can be achieved through either a reduction in taxes to spur consumer spending or through an increase in government spending. Since both of these factors – consumer and government spending – are components of the GDP, raising either or both of these components would increase output and decrease unemployment, hopefully closing the recessionary gap. With this in mind, although the tax revenue does not adequately cover the expenditures of the U.S. government, deficit spending is necessary to accomplish the economic growth desired by fiscal policy.

An opposing theory, however, is less supportive of governmental tax policy. Supply-side economics, which focuses on the factors of production that determine the amount of goods supplied, explains the desired tax rate with the Laffer curve (Moore), which is illustrated below:

Simply, the Laffer curve illustrates the relationship between the tax rate and the amount of tax collected by the government. After increasing with the tax rate, the amount of tax revenue reaches a peak and then decreases with further increases in the tax rate. There are two sets of points of note on the graph; at a tax rate of 0% and 100%, the government will collect no tax revenue. If it does not impose a tax rate, the government obviously cannot raise tax money, and  if there is a 100% tax rate, there will be no incentive for anyone to work, thus also eliminating tax revenues. The other points of note are the hypothetical 20% and 80% points, which have the same tax revenue. Since the curve slopes upward and then downward, there are infinite amounts of two coinciding points along the curve that have the same amount of tax revenue. Supply-side economists argue that if the government imposes a tax rate somewhere in the downward-sloping section of the Laffer curve, taxes are funding the government inefficiently, since the same revenue could be acquired with a lower tax rate. In this way, taxes would be more inefficient than they need to be.

Finally, the tax system can be used to even the inequality of income distribution. A video produced by the Brookings Institute outlines the pre- and post-tax income distribution in the U.S., and while income is unevenly distributed, taxes do make some difference in leveling the playing field (Wessel). As a whole, the U.S. tax system is slightly progressive, but individual taxes, especially sales tax, are regressive. Since a greater percentage of the lowest earners’ income is exposed to sales tax, it is considered regressive (Chinni). Accordingly, redistribution of wealth through taxes does some damage to income inequality, but its effects are limited. The topic of income inequality is complex, so if you are interested in learning more about where in the U.S. income inequality is the most prevalent, the importance of income mobility, or the ability of education to combat income inequality, click the links.

Overall, the effectiveness of taxes is a subjective matter. Some view more taxes as a better policy, while others favor lower tax rates. Taxes can reduce income inequality, but they can also subject the lower earners to higher effective tax rates.

Works Cited

Chinni, Dante. "The Geography and Politics of Taxes." 12 April 2015. NBC News. 12 April 2015 <http://www.nbcnews.com/meet-the-press/geography-politics-taxes-n340101>.

Cowen, Tyler. "It’s Not the Inequality; It’s the Immobility." 3 April 2015. The New York Times. 12 April 2015 <http://www.nytimes.com/2015/04/05/upshot/its-not-the-inequality-its-the-immobility.html?abt=0002&abg=1>.

Fraser, Alison. "Federal Spending by the Numbers - 2012." 16 October 2012. The Heritage Foundation. 12 April 2015 <http://www.heritage.org/research/reports/2012/10/federal-spending-by-the-numbers-2012>.

Jahan, Sarwat, Ahmed Saber Mahmud and Chris Papageorgiou. "What is Keynesian Economics?" Back to Basics September 2014.

Moore, Stephen. "The Laffer Curve turns 40: the legacy of a controversial idea." 26 December 2014. The Washington Post. The Washington Post. 12 April 2015 <http://www.washingtonpost.com/opinions/the-laffer-curve-at-40-still-looks-good/2014/12/26/4cded164-853d-11e4-a702-fa31ff4ae98e_story.html>.

Patton, Mike. "The Growth Of Government: 1980 To 2012." 24 January 2013. Forbes. 12 April 2015 <http://www.forbes.com/sites/mikepatton/2013/01/24/the-growth-of-the-federal-government-1980-to-2012/>.

The Economist. "Tax revenue." 13 December 2014. The Economist. 12 April 2015 <http://www.economist.com/news/economic-and-financial-indicators/21636056-tax-revenue?zid=293&ah=e50f636873b42369614615ba3c16df4a>.

Wessel, David. "Does the Tax System Reduce Inequality?" 12 April 2015. Newsweek. 12 April 2015 <http://www.newsweek.com/does-tax-system-reduce-inequality-321556>.

Williams, Roberton. The Numbers: What are the federal government’s sources of revenue? 13 September 2011. 12 April 2015 <http://www.taxpolicycenter.org/briefing-book/background/numbers/revenue.cfm>.