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Why does a slight tax increase cost you two hundred dollars and a substantial tax cut saves you thirty cents? -Peg Bracken You may have heard our income tax system referred to as progressive, which means the rich pay a greater percentage of their income as taxes than do the poor. Taxes can be related to income in three basic ways:
1. Progressive. A tax is progressive if the percentage tax rate rises as income rises; higher incomes are taxed proportionally higher than lower incomes.
2. Proportional. Taxes collected are a fixed percentage of income. The "flat-rate" tax proposal would institute a proportional tax.
3. Regressive. A tax is regressive if the percentage of income paid as taxes declines as income rises.
Recent federal tax laws have reinstituted much of the progressivity of taxes on income that had been flattened by a 1986 reform of federal taxes. Although more tax loopholes were also opened up, the resulting pattern of collection is moderately progressive: people with higher incomes tend to pay greater percentages of their incomes as taxes.
Social Security taxes totaling roughly 15 percent of the first $50,000 of an individual's wages are collected, and the tax is roughly proportional in the range $0-50,000 of wage income. Because Social Security taxes are not collected beyond $50,000 in wages, this tax is regressive when the entire income range is considered. Sales taxes also tend to be regressive because low income families commonly spend larger proportions of their income than high income families.
Taxing and spending are only two of the tools that government uses to mold economic activity. Laws and regulations also have very powerful economic effects. Several studies have concluded that compliance with regulation absorbs 5-15 percent of national income.
If the effects of people's choices were perfectly foreseeable and if everyone could as costlessly as possible acquire all the information bearing on every decision, the most useful mechanisms would be fairly obvious. Information is costly, and the future is uncertain. Information for decision making is sought only as long as the benefits expected from acquiring a bit more information exceed the costs. Beyond that point, we as individuals rationally choose to be ignorant. Thus, private decisions inevitably result in some mistakes because we are all somewhat rationally ignorant when we choose, and cannot know what the future holds.
One question is whether, in an environment of rational ignorance and pervasive uncertainty, government can make better decisions than we would make for ourselves. A part of the answer is that government decision-makers also operate in an uncertain environment and base decisions on only limited information. No perfect mechanisms for decision making exist. If you voted in the last election, how much did know about individual candidates and important issues? How certain were you about the policies your candidates would support as the future unfolded?
An inequitable distribution of income is one perceived flaw of a market system, and markets tend to be inefficient when firms exercise market power or when property rights are uncertain or unenforceable. At the macroeconomic level, persistent high unemployment, erratic swings of the price level, and unbalanced or sluggish growth may also signal inefficiency.
Although government is growing in the U.S. economy, regions in which government dominated economic activity for decades (e.g., Eastern Europe, China, and Vietnam) increasingly rely on market mechanisms. The growing momentum of forces from international markets is powerful evidence that no tools of economics are more important than supply and demand. The Federal Budget, 2004–2009(in billions of dollars)
Source: Department of the Treasury and Office of Management and Budget.
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