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    Taxing power

    Taxing power

    Primary tabs

    Taxing power Primary tabs Definition

    Taxing power refers to the ability of a government to impose and collect taxes.

    Overview 

    General Constitutional Authorization

    In the United States, Article I, Section 8 of the Constitution gives Congress the power to "lay and collect taxes, duties, imposts and excises, to pay the debts and provide for the common defense and general welfare of the United States. This is also referred to as the "Taxing and Spending Clause."

    Income Taxes

    Under the Sixteenth Amendment, Congress has the power to collect income taxes.

    The Internal Revenue Code is the main law governing income taxes. The Internal Revenue Code is codified as Title 26 of the United States Code.

    States 

    States are also allowed to impose and collect their own taxes, which is included but not limited to income taxes, sales taxes, and property taxes.

    Further Reading

    For more on the taxing power, see this University of Virginia Law Review article, this Arizona State Law Journal article, and this Berkeley Law Review article.

    wex taxation tax wex definitions Keywords constitutional law federal income tax income tax taxing

    Source : www.law.cornell.edu

    Laffer Curve Definition

    The Laffer Curve is the relationship between tax rates and tax revenue collected by governments.

    ECONOMY ECONOMICS

    Laffer Curve

    By ADAM HAYES Updated May 19, 2021

    Reviewed by MICHAEL J BOYLE

    Fact checked by PATRICE WILLIAMS

    What Is the Laffer Curve?

    The Laffer Curve is a theory formalized by supply-side economist Arthur Laffer to show the relationship between tax rates and the amount of tax revenue collected by governments. The curve is used to illustrate the argument that sometimes cutting tax rates can result in increased total tax revenue.

    KEY TAKEAWAYS

    The Laffer Curve describes the relationship between tax rates and total tax revenue, with an optimal tax rate that maximizes total government tax revenue.

    If taxes are too high along the Laffer Curve, then they will discourage the taxed activities, such as work and investment, enough to actually reduce total tax revenue. In this case, cutting tax rates will both stimulate economic incentives and increase tax revenue.

    The Laffer Curve was used as a basis for tax cuts in the 1980's with apparent success but criticized on practical grounds on the basis of its simplistic assumptions, and on economic grounds that increasing government revenue might not always be optimal.

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    Laffer Curve

    Understanding the Laffer Curve

    The Laffer Curve is based on the economic idea that people will adjust their behavior in the face of the incentives created by income tax rates. Higher-income tax rates decrease the incentive to work and invest compared to lower rates. If this effect is large enough, it means that at some tax rate, and further increase in the rate will actually lead to a decrease in total tax revenue. For every type of tax, there is a threshold rate above which the incentive to produce more diminishes, thereby reducing the amount of revenue the government receives.

    At a 0% tax rate, tax revenue would obviously be zero. As tax rates increase from low levels, tax revenue collected by the also government increases. Eventually, if tax rates reached 100 percent, shown as the far right on the Laffer Curve, all people would choose not to work because everything they earned would go to the government.

    It's thus necessarily true that at some point in the range where tax revenue is positive, it must reach a maximum point. This is represented by T* on the graph below. To the left of T*, an increase in tax rate raises more revenue than is lost to offsetting worker and investor behavior. Increasing rates beyond T*, however, would cause people not to work as much or not at all, thereby reducing total tax revenue.

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    Image by Julie Bang © Investopedia 2019

    Therefore, at any tax rate to the right of T*, a reduction in tax rate will actually increase total revenue. The shape of the Laffer Curve, and thus the location of T* is dependent on worker and investor preferences for work, leisure, and income, as well as technology and other economic factors.

    Governments would like to be at point T* because it is the point at which the government collects the maximum amount of tax revenue while people continue to work hard. If the current tax rate is to the right of T*, then lowering the tax rate will both stimulate economic growth by increasing incentives to work and invest, and increase government revenue because more work and investment means a larger tax base.

    Arthur Laffer acknowledges that he did not come up with the idea for his namesake curve on his own. Indeed, Ibn Khaldun, a 14th-century Muslim philosopher, wrote in his work The Muqaddimah: "It should be known that at the beginning of the dynasty, taxation yields a large revenue from small assessments. At the end of the dynasty, taxation yields a small revenue from large assessments."1

    The Laffer Curve Explained

    The first presentation of the Laffer Curve was performed on a paper napkin back in 1974 when its author was speaking with senior staff members of President Gerald Ford’s administration about a proposed tax rate increase in the midst of a period of economic malaise that had engulfed the country. At the time, most believed that an increase in tax rates would increase tax revenue.

    Laffer countered that the more money was taken from a business out of each additional dollar of income in the form of taxes, the less money it will be willing to invest. A business is more likely to find ways to protect its capital from taxation or to relocate all or a part of its operations overseas.

    Investors are less likely to risk their capital if a larger percentage of their profits are taken. When workers see an increasing portion of their paychecks taken due to increased efforts on their part, they will lose the incentive to work harder. Put together these could all mean less total revenue coming in if tax rates were raised.

    Laffer further argued that the economic effects of reducing incentives to work and invest by raising tax rates would be damaging in the best of times and even worse in the midst of a stagnant economy. This theory, supply-side economics, later became a cornerstone of President Ronald Reagan’s economic policy, which resulted in one of the biggest tax cuts in history. During his time in office, annual federal government current tax receipts from $344 billion in 1980 to $550 billion in 1988, and the economy boomed.

    Is the Laffer Curve Too Simple a Theory?

    There are some fundamental problems with the Laffer Curve—notably that it is far too simplistic in its assumptions. First, that the optimal tax revenue-maximizing tax rate T* is unique and static, or at least stable. Second that the shape of the Laffer Curve, at least in the vicinity of the current tax rate and T* is known or even knowable to policymakers. Lastly, that maximizing or even increasing tax revenue is a desirable policy goal.

    Source : www.investopedia.com

    Fiscal Policy and Economic Growth: Government's Unique Situation

    Government's Unique SituationFiscal Policy and Economic GrowthIntroductionGovernment's Unique SituationOf Deficits and DebtSo, Who's Right About Fiscal Policy? As you know, if any element of the C + I + G + (Ex - Im) formula increases, then GDP?total demand?increases.

    Fiscal Policy and Economic Growth: Government's Unique Situation

    Fiscal Policy and Economic Growth: Government's Unique Situation Government's Unique Situation

    Fiscal Policy and Economic Growth

    Introduction

    Government's Unique Situation

    Of Deficits and Debt

    So, Who's Right About Fiscal Policy?

    As you know, if any element of the C + I + G + (Ex - Im) formula increases, then GDP?total demand?increases. If the ?G? portion?government spending at all levels?increases, then GDP increases. Similarly, if government spending decreases, then GDP decreases.

    When it comes to financial management, four characteristics of the government set it apart from households and businesses (the ?C? and ?I? in the formula):

    EconoTip

    The interest rate on U.S. bonds is considered the risk-free interest rate because there is no credit risk associated with them. There is, however, the risk of inflation. Therefore, the rate on a government security represents the price to ?rent? that money for that period of time with the certainty that it will be paid back, plus any inflation premium.

    EconoTalk

    The tax base in a nation, region, state, or city is the number of workers and businesses who can be taxed. The term usually refers to income taxes, but in the case of states and cities, it also refers to sales and property taxes.

    Bracket creep occurs when inflationary pressure increases wages and pushes a worker into a higher tax bracket. This puts a ?double whammy? on the worker, who loses purchasing power?wage-push inflation often increases prices faster than wages?and pays more in taxes. But it helps keep inflationary pressures under control.Government has the power to tax, which gives it greater control over its revenue. Federal, state, and local governments can mandate higher taxes and increase their revenues. Households and businesses have the more difficult task of selling their labor, goods, and services in order to raise revenue.By increasing or decreasing taxes, the government affects households' level of disposable income (after-tax income). A tax increase will decrease disposable income, because it takes money out of households. A tax decrease will increase disposable income, because it leaves households with more money. Disposable income is the main factor driving consumer demand, which accounts for two-thirds of total demand.The federal government can finance budget deficits by borrowing in the financial markets. Investors consider U.S. government bonds to be risk free, because they are backed by the taxing power of the government. States and cities also issue bonds to finance deficits. These bonds, however, are considered riskier because the of the state or city could erode.The federal government?and only the federal government?can print more money. Like raising taxes, this has potential economic consequences (in the form of higher inflation) as well as political consequences. Nevertheless, the federal government does have that option, which is certainly not open to households and businesses.

    These unique characteristics set the government apart from the other players in the economy. They also position the federal government to formulate and implement economic policy.

    Fiscal Fundamentals

    Fiscal policy is the general name for the federal government's taxation and expenditure decisions and activities, particularly as they affect the economy. (Monetary policy refers to policies that affect interest rates and the money supply.)

    Figure 13.1 shows how C + I + G add up to determine the equilibrium level of GDP. (For convenience, we're assuming that net exports (Ex - Im) are zero.) Line ?C? represents consumption by consumers. Line ?C+I? represents consumption by consumers plus investment by businesses. Line ?C+I+G? represents consumption plus investment plus government spending.

    The 45 degree line shows all the points at which total spending equals gross domestic product. At any point on that line, the quantity demanded by the households, businesses, and government in the economy (total spending) equals the amount being produced (GDP). Whenever total demand equals total spending, the economy is in equilibrium.

    Where is the actual equilibrium point for the economy? Where the total demand of households, businesses, and government?C + I + G?equals their production. That equilibrium point occurs where the line C + I + G intersects the 45 degree line. At that point, which is point ?E? on the chart, total spending (total demand) and total production (GDP) are equal.

    What About Taxes?

    Figure 13.1 ignores taxes, but they are a crucial element in fiscal policy.

    Taxes lower households' disposable income. The amount collected in taxes doesn't find its way into consumption (?C?). But if the government spends every dollar that it collects in taxes, then that amount does find its way into total demand through government expenditures. When that occurs, the GDP remains unaffected by taxes. The size of the economy is the same whether people choose to produce and consume private goods (angora sweaters) or public goods (army uniforms). The mix of goods doesn't affect the level of GDP, as long as the total amount spent on them doesn't change.

    What happens when the government collects more in taxes than it spends?

    Source : www.infoplease.com

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