Identify Three Forces That Are Likely To Cause Future Revision Of The Tax Code

No Taxes

Value Cumulative Added Value

With a 10% Value-Added Tax

Value Added with a 10% VAT

Cumulative Value with VAT

Value Cumulative Added Value

Value Added with a 10% VAT

Cumulative Value with VAT

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Loggers fell trees and sell the timber to the mills for processing.



$1 + $.10 = $1.10


The mills cut the timber into blanks that will be used to make bats.



$1 + $.10 = $1.10


Bat manufacturers shape, paint, or varnish the bats and sell them to wholesalers.



$5 + $.50 = $5.50


The wholesalers sell the bats to retail outlets where consumers can buy them.



$1 + $.10 = $1.10


The retailers put the bats on the shelves and wait for the consumers.



$2 + $.20 = $2.20


The consumer buys the bat for:



Using Tables The VAT is like a national sales tax added to each stage of production. As a result, it is built into the final price of a product and is less visible to consumers. Is a VAT regressive, proportional, or progressive? Why?

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the global economy

High Taxes? Are You Sure?

The ratio of tax revenues to the GDP is one measure of a country's tax burden.

Have you ever thought about living in another country to avoid high taxes in the United States? If you did move, you would be in for a surprise. For all the complaints about high taxes, our federal government's revenues as a percentage of GDP are much lower than many people realize. In fact, the rate is one of the lowest in the industrial world.

Tax Revenues as a % of GDP







Source: A Citizen's Guide to the Federal Budget, FY 2000

Critical Thinking

1. Analyzing Information What is measured in the graph?

2. Sequencing Information Describe the pattern for Canada from 1991 to 1996.

cannot be vigilant about higher taxes when they cannot see them.

Another difficulty is that the VAT would compete with state sales taxes. Because the VAT is a federal tax, adding a VAT is like adding a federal sales tax to already-existing state taxes. If some of these bats were sold in Indiana, Arizona, or Texas, would those states want to forgo their sales tax simply because a federal VAT was in place? or would those states simply add their own sales taxes, thereby raising the price to $11.50 or even higher?

The Flat Tax

TiB The concept of a flat tax-a proportional tax {■I on individual income after a specified threshold has been reached-did not receive much attention until Republican candidate Steve Forbes and others raised the issue in the 1996 presidential elections. Supporters promoted the flat tax as a way to both simplify taxes and stimulate growth.

A "Progressive" Flat Tax?

A pure flat tax would tax all income at a specific rate, such as 15 or 20 percent. Since the lowest tax rate for all Americans is already 15 percent, critics viewed the proposal as a way to provide tax breaks for the wealthy. As a result, most flat tax proposals exempt some income.

Consider a 15 percent flat tax that exempts the first $20,000 of income. According to this system, a person with exactly $20,000 pays nothing in taxes, and therefore has a zero average tax rate. Someone who earns twice as much would pay nothing on the first $20,000, and 15 percent on the next $20,000. Taxes would amount to $3,000, for an average tax rate of 7.5 percent ($3,000 divided by $40,000). Likewise, someone who earned $60,000 would pay $6,000 (15 percent of $40,000), and have an average tax rate of 10 percent ($6,000 divided by $60,000).

Because the average tax in the example above—0, 7.5, and 10 percent respectively—increases as income increases, the tax is progressive. As a result, a flat tax can be progressive as long as some income is exempted.

Advantages of the Flat Tax

The primary advantage of the flat tax is the simplicity it offers to the taxpayer. A person would still have to fill out an income tax return every year, but many current procedures, such as itemizing deductions, could be skipped.


A second advantage is that a flat tax closes or minimizes most tax loopholes. Under today's tax code, for example, the donation of a single artwork can substantially reduce a millionaire's tax liability.

A third advantage is that a flat tax reduces the need for tax accountants, tax preparers, and even large portions of the IRS. Overall, the savings to everyone could be as high as $100 billion annually.

Disadvantages of the Flat Tax

The first disadvantage of the flat tax is that it removes many of the behavior incentives already built into the tax code. For example, the current tax code allows homeowners to deduct interest payments on home mortgages. Other incentives include deductions for donations to charitable organizations, and education and training.

Eliminating these incentives is likely to encounter some resistance. For example, Money Magazine warned that a 15 percent flat tax would hurt homeowners because they could no longer deduct mortgage interest payments. The writer also noted that, "under his own plan, multimillionaire Steve Forbes could see his personal tax bill cut by almost two-thirds." This, of course, highlights the second problem with the flat tax—namely that it will benefit those with high incomes at the expense of lower-income individuals.

To illustrate, suppose that a single individual has $50,000 of taxable income and is subject to the tax rates shown in Figure 9.5. Taxes for this individual would amount to $3,862.50 plus 28 percent of the difference between $50,000 and $25,750—for a total tax bill of $10,653. Under a 15 percent flat tax that exempts the first $40,000, the same individual would owe taxes of $1,500—a total tax saving of $9,153!

On the other hand, if that same person had taxable income of $1,000,000, the total amount of taxes owed according to Figure 9.5 would be $374,073. Under the same 15 percent flat tax plan, the individual would owe $144,000 instead—for a tax saving of $230,073.

Who benefits the most? The person with a $50,000 income who gets an 86 percent tax reduction and saves $9,153, or the person with a $1,000,000 income who gets a 61.5 percent tax reduction and saves $230,073? Any flat tax, regardless of the size of the up-front exemption, is a dramatic shift away from the ability-to-pay principle of taxation.

Flat Tax Proposals

Several congressional candidates during the 1996 election campaign presented various flat tax proposals. Shortly after the election, Republican House Majority Leader Dick Armey presented his version. Armey's plan offered a 17 percent flat tax on individual income that would exempt the first $35,400 earned by a family of four. Businesses would also be subject to a 17 percent tax rate.

Would taxpayers be better off under this proposal? The answer depends on how much you make and how you make it. For example, only labor income from wages, tips, salaries, and pensions would be taxed under the Armey plan. Incomes from dividends, interest, and capital gains are excluded. Critics argued that these exclusions—especially capital gains—favored the wealthy.

Public Accountant

Public Accountant

Accountants prepare, analyze, and verify financial reports that provide information to the general public and to business firms.

The Work

They check clients' financial records, ensuring that they conform to standard procedures for reporting. They give advice on tax advantages and disadvantages, on setting up an accounting system and on managing cash resources, and they prepare income tax statements.


Most firms require applicants to have, at the minimum, a bachelor's degree in accounting or some closely related field. Accountants must be good at mathematics, be able to compare, analyze, and to interpret numbers and facts, and to make sound judgments.

House Minority Leader Dick Gephardt countered Armey's proposal with a "10% Plan." Under Gephardt's plan, a family of four would pay no taxes on income up to $27,500, and then would pay at a 10 percent rate up to $61,000. After that level, the marginal tax bracket would increase in increments to the maximum rate of 34 percent.

Would a flat tax stimulate economic growth? Critics point out that the extraordinary growth of the American economy in the 1990s, the longest period of peacetime prosperity in our history, sheds doubt on the claim that the current system hinders growth.

Second, no one knows exactly what rate is needed to replace the revenues already collected under the current system. Estimates by economists who proposed the tax, as well as estimates done by the United States Treasury, place the tax closer to 23 percent-which represents more of a burden on low-income earners.

The Inevitability of Future Reforms

There were more changes, additions, deletions, exceptions, and exclusions made to the federal tax code in the 1980s and 1990s than at any time in our history. Several factors ensure further change.

First, the tax code is more complex now than ever-a fact that guarantees future attempts to simplify it. The flat tax movement, for example, has moved beyond the point of being a campaign strategy to the stage where Congress is seriously considering such a tax.

Second, the strong economy of the 1990s resulted in record tax collections. For the first time in 30 years, the government collected more revenues than it spent. As a result, many political leaders began to consider ways to lower taxes.

Third, political change is not like economic change, which is gradual and generally evolutionary. Political change is more abrupt, with less continuity from one period to the next, as one party leaves office and another enters. New administrations often display a sense of urgency, a desire to finally do things the "right" way, or to clean up the excesses of their predecessors.

Yet, dramatic change is tempered by the reluctance of politicians to give up some of the power they currently exercise through the tax code-power vested in the ability to modify behavior, influence resource allocation, support pet projects, and grant concessions to special interest groups. As the editorial in the cover story aptly put it, "The tax code is the way it is because a majority of Congress wants it that way."

Stctitu 4 Atwisnieilt

Checking for Understanding

1. Main Idea What is the purpose of tax reform?

2. Key Terms Define accelerated depreciation, investment tax credit, surcharge, alternative minimum tax, capital gains, value-added tax, flat tax.

3. Describe three major tax reform bills since 1980.

4. Explain the advantages and disadvantages of the VAT.

5. Describe the features of the flat tax.

6. Identify three forces that are likely to cause future revision of the tax code.

Applying Economic Concepts 7. Flat Tax What do you think might happen to donations to charitable organizations if there was a flat tax? If possible, support your answer with examples.

-Critical Thinking -

8. Summarizing Information What changes would you recommend in the federal tax code if you were in charge of revising it? Explain your answer.

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  • rhianna
    What factors are likely to cause future revisions of the tax code?
    2 years ago

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