Ch 7: Income Taxes

Question 1

No capitation, or other direct, tax shall be laid, unless in proportion to the census or enumeration herein before directed to be taken.”

Answer 1

U.S. Constitution, Article I, Section 9

Question 2

Also known as the Income Tax Act of 1894

Answer 2

Wilson-Gorman Tariff Act
* Reduced tariffs imposed by the McKinley tariff
* 2% tax on interest, dividends and rents above $4,000 (over $120,00 in 2020)
* Applied to less than 1% of pop.
* Created the Bureau of the Internal Revenue (now Internal Revenue Service)

Question 3

1895—the Supreme Court’s decision in Pollock v. Farmers’ Loan & Trust Co.

Answer 3

found the Wilson-Gorman Tariff Act to be unconstitutional

Question 4

1909—President William Howard Taft proposed

Answer 4

constitutional amendment to allow for an income tax

Question 5

1913—The XVI Amendment ratified

Answer 5

allows the Congress to collect taxes on income—regardless of source
of income—without apportioning it among the states or basing it on census results
– Congress levied a 1% tax on incomes of more than $3,000, and a 6% tax on incomes of more than $500,000
* $3,000 in 1913 is equivalent in purchasing power to about $78,387.27 in 2020
* $500,000 in 1913 is equivalent in purchasing power to about $13,064,545 in 2020
– Introduced Form 1040 (the same basic form that is used today)

Question 6

Equity

Answer 6

Income is an adequate ability-to-pay measure
– Income can be adjusted to fit taxpayer conditions

Question 7

Yield

Answer 7

Adequate yield based on income
– Income (Tax) base positively related to economic conditions

Question 8

Distortion

Answer 8

Economic decisions not markedly distorted because the tax base
(income) is large in scope

Question 9

Disadvantages of taxing income

Answer 9

Lack of transparency and complicated
– Hard to comply with
– Tax loopholes
* Expensive to administer
– only when taxpayer cost is included
* Distorts economic choices
– Tax applies to interest earned
* Consumption is encouraged
– Unequal effective tax rates on capital investment
* Economic resources manipulated looking for tax advantages
* Equity
– Not progressive enough versus not proportional enough
– Too many loopholes allow some not to pay enough
* Overuse
– Compounds inequities and distortions because of the scope of use

Question 10

xx% choose standard deductions

Answer 10

66%

Question 11

Tax rates increase in steps as

Answer 11

income increases.

Question 12

Marginal tax rate

Answer 12

the rate paid on the next dollar of income earned.

Question 13

Tax deduction vs tax credit

Answer 13

While a tax deduction reduces your taxable income, a tax
credit reduces the amount of tax you owe the IRS.

Question 14

Biggest anti-poverty program for low to moderate income individuals and families

Answer 14

Earned Income Tax Credit
* Maximum of $6,557 with three or more qualifying children
* $529 with no qualifying child
* Reaches zero as earnings pass $55,952 (married filing jointly/3+ children)
* The dollar amounts are indexed annually for inflation

Question 15

Bracket Creep

Answer 15

Taxpayers pushed into a higher tax bracket without effectively making more money.

Question 16

_____ removes the effect of bracket creep

Answer 16

Indexation

Question 17

The federal income tax has indexed exemptions, standard
deductions, and bracket points since

Answer 17

1985

Question 18

Corporate income tax applies to

Answer 18

total net earnings

Applies to both earning retained by the firm and those disbursed to
stockholders

Charitable contributions are deducted

Question 19

Characteristics of payroll taxes

Answer 19

Narrow bases and exclude income more likely to be received by high-income individuals (dividends)
– People with similar incomes would pay different amounts based on the kind of income (dividend income is excluded)
– Social Security–As of 2019, the employer must withhold 6.2% of an employee’s wages (up to $132,900) and pay a matching amount.
– Self-employed individuals pay tax at a 12.4% rate up to the limit.
– Medicare–As of 2019, the employer must withhold 1.45% of an employee’s wages and must pay a matching amount—no max wage base as in SS taxes

Question 20

Advantages of flat tax rate

Answer 20

– Simple and less expensive to administer
– Fair because everyone pays the same rate?
– It stimulates the economy by removing economic disincentives to invest,
which would help the poor?
* The poor would in turn pay more in taxes because their income would have gone up due
to more employment opportunities and better wages

Question 21

Disadvantages of flat tax rate

Answer 21

Would be simple and less expensive to administer only if it were a true flat
tax rate (unrealistic)
– ‘Fair’ to the extent that there are no deductions for accumulated wealth,
capital losses, etc.
– Regressive—why?

Question 22

These states have no state income tax on wages

Answer 22

New Hampshire and Tennessee

Question 23

These states have no state income tax

Answer 23

Alaska, Florida, Nevada, South Dakota, Texas