Fundamental Tax

Front 1

How do tax payments differ from other payments that people or organizations make to governmental agencies?

Back 1

Tax payments differ from government fines and penalties because they are not intended to deter or punish unacceptable behavior. Tax payments differ from fees or user charges because they do not entitle the payer to a specific government good or service, such as a postage stamp or a driver’s license. Tax payments also differ from fees or user charges because they are compulsory.

Front 2

The Green River, which is heavily polluted by industrial waste, flows through State S. Eighthy-five companies operate manufacturing facilities that border the river. State S recently enacted legislation requiring each company to pay $50,000 annually into a special fund to clean up Green River. Does this payment meet the deifinition of tax?

Back 2

2. This payment has characteristics of a tax, a penalty, and a user fee. The compulsory payment is not specifically punitive but does apply selectively to those companies most likely responsible for the polluted condition of Green River. However, these same companies may be the entities that benefit most from the environmental clean-up.

Front 3

Custer County is considering raising revenues by imposing a $25 fee on couples who obtain a marriage license within the county. Does this fee meet the definition of a transaction-based tax?

Back 3

This payment more closely resembles a fee for a government service than a transaction-based tax because the transaction occurs between a private party and the jurisdiction itself, rather than between private parties engaging in a market transaction. The payment also entitles the payer to a specific benefit (the right to marry under law).

Front 4

MrP. owns a residential apartment complex in a suburban area. This year, the local jurisdiction increased the property tax rate on the apartment complex. To offset this additional cost, Mr. P decreased the amount he usually spends on maintaining the exterior of the building and the landscaping. Who bears the incidence of the increased property tax?

Back 4

To the extent that the decline in exterior maintenance reduces the value of Mr. P’s apartment complex, he bears the incidence of the increased property tax. To the extent that the decline reduces the value of adjoining properties or makes the neighborhood less attractive, the owners of the adjoining properties and the neighborhood residents share the incidence of the tax increase.

Front 5

Mr. and Mrs. K pay $18,000 annual tutiton to a private school for their three children. They also pay $2300 property tax on their personal residence to support the local public school system. Should Mr and Mrs K be exempt from the property tax?

Back 5

People who do not directly use public schools (such as Mr. and Mrs. K or people who do not have children) indirectly benefit from a public education system for the general population. Arguably, public education contributes to a skilled workforce and improves the cultural and social environment in which Mr. and Mrs. K live. Based on this argument, Mr. and Mrs. K should not be exempt from the local property tax.

Front 6

A local government imposed a new 2 percent tax on the gross receipts of businesses operating within its jurisdiction. XYZ company, which manufactures soap and other toiletries, responded to the tax by reducing the size of its bars of soap and purchasing a cheaper grade of ingredients. By making these changes, XYZ maintained its before tax level of profits. Who bears the incidence of the new gross receipts tax?

Back 6

The consumers who pay the same price for a smaller bar of soap of lesser quality bear the incidence of the new gross receipts tax.

Front 7

Why is real property a better tax base than personal property?

Back 7

Real property cannot be hidden or moved, and its ownership (legal title) is a matter of public record. In contrast, personal property is mobile and may be easily concealed. Moreover, jurisdictions may not have an effective means to discover or trace ownership of personal property.

Front 8

University K is located in a small town that depends on real property taxes for revenue. Over the past decade, University K has expanded by purchasing a number of commercial buildings and personal residences and converting them to classrooms and dormitories. In what way could this expansion result in a decline in the towns revenues?

Back 8

Many jurisdictions that levy property taxes provide an exemption for public institutions, such as state universities or private colleges. If University K is entitled to such an exemption, every commercial building or residence acquired by the University reduces the local jurisdiction’s property tax base.

Front 9

Why can people avoid paying an excise tax more readily than they can avoid paying a sales tax?

Back 9

Excise taxes are imposed on a much narrower range of consumer goods and services than sales taxes. Consequently, people can more readily avoid purchasing the specific good or service subject to excise tax.

Front 10

A city government increased its local sales tax from 1 percent to 2 percent of the dollar value of consumer goods purchased in the city. HOwever, the city's sales tax revenues increased by only 30 percent after the doubling of the tax rate. What factors might account for this result?

Back 10

The tax increase may have reduced the aggregate demand for consumer goods and, consequently, municipal residents are buying fewer goods. A second possibility is that municipal residents are traveling to other jurisdictions with lower tax rates or making more purchases through mail order catalogs or on-line.

Front 11

Both the federal government and many states impose so-called sin taxes: excise taxes levied on the retail sale of liquor and cigarettes. Dicuss the reasons why sales of these particular items make a good tax base.

Back 11

From a political perspective, liquor and cigarettes sales make an excellent tax base because consumption of the two products is purely discretionary, and any decline in consumption because of the tax is socially desirable. From an economic perspective, these sales are a good tax base because the demand for liquor and cigarettes is relatively price inelastic. In other words, people who drink and smoke on a regular basis buy these products regardless of a heavy excise tax.

Front 12

Firm L, which operates a mail-ordered clothing business, is located in State L. This year, the firm shipped $18 million of merchandise to customers in State R. State R imposes a 6 percent sales and use tax on the purchase and consumption of retail goods within the state. Do State R residents who purchased from Firm L merchandise owe use tax on their purchsaes? IF State R could legally require Firm L to collect a 6 percent tax on mail-order sales made to residents of the state, how much additonal revenue would the state collect? Explain.

Back 12

a.State R residents who purchase property out-of-state (i.e., through the mail) but use and consume the property in State R owe the 6 percent use tax.

b.The fact that Firm L must collect the State R use tax does not affect the legal liability of State R residents to pay the tax. However, very few people actually pay a self-assessed use tax. Thus, State R might collect as much as $1,080,000 additional revenue (6 percent of $18 million sales to State R customers) if Firm L was required to collect use tax at point of sale and remit the tax to State R.

Front 13

What evidence suggests that the federal tax system receieves a low grade when evaluated on the standard of sufficiency?

Back 13

Historically, the federal income tax system has not generated enough revenue to fund the government’s spending programs. Consequently, the federal government has borrowed money to make up its deficits (excess of spending over revenues) and in doing so has amassed an $11 trillion national debt. The federal government operated at a deficit in every year from 1970 through 1998. In 1999 and 2000, it operated at a small surplus (excess of revenues over spending), but reverted to massive deficit spending in 2001 and subsequent years.

Front 14

Identify three ways that government can alter their tax systems to increase revenues

Back 14

Governments can impose a new tax (by identifying and taxing a new base), increase the rate of an existing tax, or expand the base of an existing tax.

Front 15

National govts have the authoruty to print thier own currency. Why might govts be relutant to finance an operating deficit(excess of spending over revenues) simply by printing more money?

Back 15

Governments that fail to control the growth of their money supply run the risk of devaluing the currency and triggering a crippling rate of inflation. Therefore, simply printing more money to fund an operating deficit is not a viable, long-term solution to an insufficient tax system.

Front 16

In each of the following cases, discuss how the taxpayers might respond to a tax rate increase in a manner consistent with the income effect.
a. Mr E earns 32,000 a year as an employee, and Mr E doesnt work
b. Mr F earns 22000 a year as an employee, and Mrs F earns 10000 a year as a self employed worker
c. Mr G earns 22000 a year as an employee, and Mrs G earns 10000 a year as an employee

Back 16

a.Mrs. E could enter the work force. Her after-tax earnings could offset the decrease in the couple’s disposable income attributable to the tax rate increase. If Mr. E works for an hourly wage, he could possibly work more hours for his employer. If he doesn’t have this option, he could take a second job or even start a new business.

b.As a self-employed individual, Mrs. F may have the flexibility to increase the number of hours devoted to her business. Her additional after-tax earnings could offset the decrease in the couple’s disposable income attributable to the tax rate increase. Mr. F has the same options as Mr. E.

c.In this case, Mr. and Mrs. G have the same options as Mr. E and Mr. F. Because they are both full-time employees, their ability to increase their before-tax income may be limited.

Front 17

In each of the following cases, discuss how the taxpayers might respond to a tax rate increase in a manner consistent with the substitution effect.
a. Mr H earns 195000 a year as a salaried employee, and MRs H dont work
b. Mr J earns 195000 a year as a salaried employee, and mrs J earns 38000 a year as a salaried employee.
c. Ms K is single and earns 195000 a year as a self employeed consultant

Back 17

a.Mr. H may not have any realistic way to decrease the time spent at work and increase his leisure time, even if the after-tax value of his labor decreases because of a tax rate increase. Mrs. H’s behavior should not change because of a tax rate increase.

b.Mrs. J could quit her job and leave the work force if the couple decides that her leisure time is worth more than the after-tax value of her labor.

c.As a self-employed individual, Ms. K has the flexibility to decrease the number of hours devoted to her business, thereby substituting additional leisure time for labor.

Front 18

The federal government levies a gift tax on the value of property that people give away during their life and an estate tax on the value of property that people transfer at death. From the governments perspective, which tax is more convenient?

Back 18

Arguably, the estate tax is more convenient for two reasons. First, individuals with accumulated wealth can’t avoid the tax indefinitely. Second, a person’s death is a matter of public record so that the IRS can easily determine when a potentially taxable event (the transfer of wealth at death) has occurred.

Front 19

Jurisdiction R and Jurisdiction S both impose a personal income tax on their residents. Under Jurisdicton R's system, employers are required to withold income tax from their employees paychecks and remit the tax to the govt. Jurisdiction S's system has no such witholding requirement. Instead, residents must compute their income tax and pay the tax directly on a monthly basis. Which tax system is more convient for the govt and taxpayer?

Back 19

Clearly, the system in which employers must withhold and remit income tax from their employees’ paychecks is more convenient for the government because the collection process is greatly concentrated. The withholding system is more convenient for individual employees who are not required to compute their monthly tax bills or mail tax payments to the government. Instead, their employers perform these tasks on the individuals’ behalf. The withholding system shifts much of the cost of compliance to employers and is, therefore, more inconvenient from the employers’ perspective.

Front 20

The federal income tax is criticized as being both inequtable across individuals and overly complicated. Discuss why equity and simplicity can be considered conflicting tax policy goals.

Back 20

For the income tax system to be equitable, the tax base (taxable income) should be defined as precisely as possible to reflect each individual’s economic ability to pay. However, the greater the number of personal and financial circumstances taken into account in defining taxable income, the greater the complexity of the law.

Front 21

Ms P is considering investing 20000 in a new business. She project that this investment should generate 3000 income each year. IN estimating her tax on this future income stream, should Ms P use her marginal or her average tax rate?

Back 21

Ms. P should consider her marginal rate: the rate at which the incremental income from the investment will be taxed. For tax planning purposes, the average tax rate that she pays on her entire income is irrelevant.

Front 22

Does the after tax cost of a deductible expense increase or decrease as the taxpayers marginal income tax rate increases?

Back 22

The after-tax cost of a deductible expense decreases as the taxpayer’s marginal rate increases.

Front 23

Firm A and Firm Z are in the same business. Both firms considered spending $10,000 for the exact same reason. THe expenditure would be deductible for both firm. Firm A decided that the expenditure was worthwhile and spent the money, but Firm Z rejected the expenditure. Can you provide a tax reason to explain these apparenly inconsistent decisions?

Back 23

Firm A has a higher marginal tax rate than Firm Z. Consequently, Firm A’s after-tax cost of the expense is less than Firm Z’s and low enough to justify the expenditure.

Front 24

Which assumption about the tax consequences of a future transaction is more uncertain: an assumption based on a provision that has been in the Internal Revenue Code for 25 years or an assumption based on a provision that Congress added to the Code two years ago?

Back 24

Assumptions based on new tax rules and regulations, which may or may not stand the test of time, are more uncertain than assumptions based on enduring provisions of the federal tax law.

Front 25

Which type of tax law provision should be more stable and less uncertain as to its future application: a provision relating to the proper measurement of a taxable income or a provision designed to encourage individual taxpayers to engage in a certain economic behavior?

Back 25

Provisions relating to the proper measurement of taxable income are more likely to be part of the fundamental structure of the law than provisions designed to affect economic behavior. The latter reflect fiscal policies that may change with each new Congress or Presidential administration. Consequently, they are less stable and more uncertain than provisions relating to income measurement.

Front 26

COUNTENANCE

Back 26

COUNTENANCE (KOWN tuh punts) v to approve of or tolerate

• Her refusal to countenance any of what she called "backtalk" made her an unpopular babysitter, but even the children had to admit that things were less chaotic when she was around.

• The dean fully countenanced the addition of the new athletic complex, saying that a healthy body would only aid in the development of a healthy mind.

Countenance can also be a noun, in which case it means mien, face, composure.

• The countenance of the woman in Dorothea Lange's famous photograph, "Migrant Mother, Nipomo, California" is one of the most powerful and enduring images of the Great Depression; the woman's face communicates such fear and despair, and yet also strength, that it has become iconic.

Hint 26

picture the count putting a stamp of approval on a stack of papers.

Front 27

Taxpayer Y, who has a 30 percent marginal tax rate, invested 65000 in a bond that pays 8 percent annual interest. Compute Y's annual net cash flow from this investment assuming that:
a. The interest is tax exempt income
b. The interest is taxable income

Back 27

a. Taxpayer Y will receive $5,200 annual before-tax cash flow ($65,000  8%) and pay no tax on the receipt. Therefore, his after-tax net cash flow is also $5,200.
b. Taxpayer Y will receive the same annual before-tax cash flow. Because the cash flow is taxable income, he must pay $1,560 tax ($5,200  30% marginal tax rate). Therefore, Taxpayer Y’s after-tax net cash flow is $3,640 ($5,200 – $1,560).

Front 28

Firm E must choose between two alternative transaction. Transaction 1 requires a 9000 cash outlay that would be nondeductible in the computation of taxable income. Transaction 2 requires a 13500 cash outlay that would be a deductible expense. Determine which transaction has the lesser after tax cost, assuming that:
a. Firm E marginal tax rate is 20 percent
b. Firms Es marginal tax rate is 40 percent

Back 28

a. Transaction 1 Transaction 2
Cash outlay $(9,000) $(13,500)
Tax savings at 20% -0- 2,700
After-tax cost $(9,000) $(10,800)
Transaction 1 has the lesser after-tax cost.

b. Transaction 1 Transaction 2
Cash outlay $(9,000) $(13,500)
Tax savings at 40% -0- 5,400
After-tax cost $(9,000) $(8,100)
Transaction 2 has the lesser after-tax cost.

Front 29

Mr L performed minor construction work for a number of people who paid him in cash. Because Mr L knows that there is almost no chance that the IRS could learn of these payments, he reports only half the payments as income on his federal tax returns.

Back 29

Mr. L is engaging in tax evasion because he is deliberating understating income (and thus his tax liability) for the year.

Front 30

Mr P, who is in the 35 percent tax bracket, recently had the opportunity to invest $50,000 in a new business that should yield an annual return of at least 17 percent. Rather than invest himself, Mr P gave 50000 cash to his son, who then made the investment. The sons marginal tax rate is only 15 percent

Back 30

Mr. P is engaging in tax avoidance. He has not earned any income that he fails to report. Instead, he is giving his son an opportunity to earn income that will be taxed at a lower marginal rate than if Mr. P earned it.

Front 31

Mrs Q sold an asset during January. Her 12000 profit on the sale is ordinary income. After preparing her income tax return for the prior year, Mrs Q relaized that her marginal tax rate for that year was 28 percent. She also realized that her marginal rate for this year will be 35 percent. Mrs Q decides to report the profit on her prior year return to take advantage of the lower tax rate

Back 31

Mrs. Q is engaging in tax evasion because she is deliberately violating the rule requiring taxpayers to report and pay tax on income in the proper year. She is filing her prior year return based on false information (the year of sale).