# Taxes and the Economy Essay

Submitted By polymathk
Words: 1053
Pages: 5

Thomas Jefferson famously said the only things in life that were certain were death, and taxes. Taxes are an important part of an economy.
The strength of an economy depends largely upon the income of its participants. A major factor in determining tax rates and planning tax revenue is income along with income distribution. The most common graphical representation of income distribution is the Lorenz Curve. On a Lorenz Curve, percentage of population is plotted on the horizontal axis, while percentage of income and wealth is plotted on the vertical axis.

Percentage Of Y and wealth % of population The diagonal line represents equality. If the bottom 20 percent of the population made 20 percent of the nation’s overall income, followed by the bottom 40 percent of the population making 40 percent of the nation’s overall income etc., the graph of the Lorenz curve would be a 45 degree diagonal line. The further the Lorenz Curve is from this line, the more unequal the income distribution. The Gini coefficient represents the ratio of the area “inside” of the curve to the total area between the line of equality and the far right hand corner of the graph. The smaller the ratio, the more equal the distribution of income. The ability to pay criterion bases tax rates on the household’s ability to pay. Things that are taxed by state, federal, and local government result in different percentages of each person’s overall income. Suppose Sue purchases a pair of shoes for \$100 with a sales tax of 8.25 percent, and Jane buys the same shoes with the same tax rate. Sue, who makes \$200 a week, would pay out a higher percentage of her income on taxes than Jane who makes \$400 a week. From this we can conclude that Jane’s ability to pay the sales tax is higher than Sue’s. A sales would be considered an indirect tax. An indirect tax is based on purchased goods. A direct tax is based on income and wealth.
There are primarily three types of tax rates: Progressive, Regressive, and Proportional. A progressive tax rate increases as income increases, and decreases as income decreases. Notice too, that a progressive tax rate’s dependence on income makes it a direct tax. An example of a progressive tax is The Federal Withholding Income Tax. The graph pictures Marty’s Federal Income Tax: Taxable Income | Tax Bill | Nominal Tax Rates | Effective Tax Rates or Average | \$25,000 | \$5,000 | 20% | 14.3% | | | | |

Marty’s total income is 35,000. Before any of his income is taxed, his total income is subject to exemptions and deductions, which are loosely defined as people who are financially dependent on Marty and line items, respectively. Exemptions and deductions exclude a portion of one’s income from being taxed. After exemptions and deductions are calculated, Marty’s taxable income is \$25,000. With a nominal tax rate of 20 percent, Marty’s tax bill is 5,000. Maria’s income is \$150,000 before taxes. After she calculates deductions and exemptions, her taxable income is 100,000. Taxable Income | Tax Bill | Marginal Tax Rates | Nominal Tax Rate | Effective Tax Rate or Average | 1st \$25,000 | \$5,000 | 20% | 20% | | 2nd \$25,000 | 10,000 | 40% | 30% | | 3rd \$25,000 | 12,500 | 50% | 36% | | 4h \$25,000 | 15,000 | 60% | 42.5% | 28.3% | | Total Tax Bill \$42,500 | | | |

In the above graph, as Maria’s income increases, so does her tax rate. Each \$25,000 of her income places her in a different tax bracket, or higher tax rate. To determine the marginal tax rate, the tax bill incurred is divided by each additional increment of the income that is taxable. The first \$25,000 of Maria’s income has a tax bill of \$5,000, and the next 25,000 of her income has a \$10,000 tax bill:
\$10,000(tax bill)/25,000(taxable income)=.4 or 40%
So 40 percent is the marginal rate for that tax