Why can raising tax rates fail to generate an increase in tax revenues Quizlet

A graduated rate structure with rates that decrease as the base decreases.

Tax policy makers agree that regressive rates are inequitable because they place a proportionally greater tax burden on persons with smaller tax bases. However, the regressive nature is not always obvious from its rate structure.

Retail sales taxes consist of only a single rate and therefore are not explicitly regressive. Even so, many economists criticize these taxes as implicitly regressive in operation, bearing most heavily on people with the least economic resources.

Mr. James and Mr. Kim live in Maryland, which has a 5 percent sales tax on all retail purchases. Mr. James earns $20,000 annual disposable income and spends the entire amount on taxable purchases. Mr. James pays $1,000 sales tax and his average tax rate (with respect to disposable income) is 5 percent.

$1,000 tax / $20,000 base = 5% average tax rate

In contrast, Mr. Kim earns $100,000 annual disposable income, spends only $75,000, and invests the remaining $25,000. Mr. Kim pays $3,750 sales tax, and his average tax rate is 3.75 percent.

$3,750 tax / $100,000 base = 3.75 tax rate

This doesn't actually exist

Who decides the Fiscal Policy? The President and Congress make basic fiscal policy decisions during the budgetary process.

The fiscal policy can changes either, or both:
1. The Government Expenditure (G)
2. The net taxes, T (total tax revenue minus transfer payments made by the Government)

• Built-in, or automatic stabilizers (non-discretionary fiscal policy): they change automatically, as economic conditions change, and they counteract the business cycle.
- Example: During recession, unemployment benefit rises, or during boom, tax revenues rises due to higher income (which lowers the inflationary gap)

• Discretionary fiscal policy: changes in government spending and taxation designed to achieve specific macroeconomic goals. - Example: Building new roads and infrastructure

The discretionary part needs to be changed annually, the built-in part automatically adjusts

1. Higher taxes/lower spending. To ensure a budget surplus, the government will have to cut spending and/or increase taxes. It depends on economic growth and demographic factors. For example, with an ageing population (requiring more pension spending) achieving a budget surplus will be harder.

2. Impact on growth. If the government is forced to increase taxes / cut spending to meet a budget surplus, it could have an adverse effect on the rate of economic growth. If government spending is cut, then it will negatively affect AD and could lead to lower growth.

A budget surplus doesn't have to cause lower growth. If the economy is booming, then a budget surplus could be compatible with strong economic growth. Also, even if the government increase taxes, the Bank of England could ease monetary policy to maintain strong growth. In fact, in a booming economy, Keynesian economics suggests that a budget surplus could help prevent excess growth and inflation.

3. Impact on household debt. Austerity has a strong political appeal because there is a dislike of the idea of debt. But, a government budget surplus could ironically lead to higher household debt. In the financial crisis, household debt as % of GDP fell as consumers/firms tried to pay off debt. This led to a fall in spending, which was partly offset by a rise in government borrowing.

4. Impact on cost of borrowing. One argument for running a budget surplus is that it will reduce levels of national debt, and push down bond yields and reduce the amount of debt interest payments future generations pay. This will make it cheaper for the government to borrow.

5. Impact on ability to survive future problems.

One argument for running budget surpluses is that it gives you more scope for meeting a future crisis. If you meet a future crisis with debt at 100% of GDP, it may be difficult to pursue expansionary fiscal policy. If debt has fallen to 50% of GDP, there is less need to panic.

However, if budget surpluses reduce the rate of economic growth, then this will damage the long-term potential of the economy. It is worth bearing in mind, that the UK began the 1950s with the national debt at 200% of GDP, but it was no barrier to a golden age of economic prosperity and rising living standards. National debt doesn't have to saddle future generations with poor prospects.

6. Impact on investment

If the government is committed to running a budget surplus, it is likely the government will need to cut back on public sector investment. - Investing in railways, roads, housing, communication, education, skills, training. These are all areas where this market failure. Private firms will not build new roads or fix potholes because they are effectively public goods. If the government cut back on investment, it could harm the long-term productive capacity of the economy.

Some feel the idea of government borrowing is very wrong. But, it should be remembered successful firms borrow for investment, households borrow to fund a mortgage. The economy can benefit from public sector investment. The rate of return on public sector works can be significantly higher than the current borrowing costs.

Why will an increase in tax rate not necessarily increase government revenue?

How does an increase in the tax rate change the tax revenue quizlet?

What happens if a government increases the tax rate?

What will an increase in the tax rate cause quizlet?