Taxation and the National Debt
Is there a fair and efficient way to fund and maintain the public services we want?
In this world nothing can be said to be certain, except death and taxes.
—Benjamin Franklin, 1789 (Martin, 2012)
I, _______________, pledge to the taxpayers of the ___ district of the state of ____, and to the American people that I will: ONE, oppose any and all efforts to increase the marginal income tax rates for individuals and/or businesses; and TWO, oppose any net reduction or elimination of deductions and credits, unless matched dollar for dollar by further reducing tax rates.
—U.S. House Taxpayer Protection Pledge (Americans for Tax Reform, n.d.)
Here’s the truth: The only way America can reduce the long-term budget deficit, maintain vital services, protect Social Security and Medicare, invest more in education and infrastructure, and not raise taxes on the working middle class is by raising taxes on the super rich.
—Former Secretary of Labor Robert Reich (2011)
Public services must be paid for with taxes. The pledge that the Americans for Tax Reform have asked all new members of Congress to sign since 1986 exacts an absolute promise not to vote to raise taxes of any kind, including the marginal tax rate. The marginal tax rate can be used to compel wealthy people to pay a higher proportion of their income than middle income or poor people pay. Robert Reich argues, in contrast, that firm caps on taxes, especially for the wealthy who are most able to pay, have significant opportunity costs in the form of reduced government services, increased taxes on the middle and working class, or increased deficits.
Some may wonder why we have deficits or debt at all if the government has nearly unlimited authority to tax residents—why don’t we just tax our way out of debt? Others wonder, given the obvious costs and loss of economic freedom, if it wouldn’t be preferable to simply eliminate most or all taxes, public goods, and services and allow people to spend money as they please.
In between these two extremes, there are challenging and nuanced questions that can be examined using the tools and evidence of economics.
How can we generate the revenue we need to pay for public services without disrupting the economy by reducing the ability of people to pay for goods and services?
Would we accept a tax system that generates enough revenue, but encourages undesirable behavior. Is such a system sustainable?
- How do we decide if taxes are “fair”? Should senior citizens have to pay for schools they will never use? Should pacifists be expected to pay taxes that go to support the military? Should the wealthy be asked to pay more because they are able, or is that punishing success?
This lesson explores these issues by examining the gas tax and the capital gains tax on investment income. Students will begin with the question of why we tax. Then, they will compare the cost of taxation to the costs of deficits and debt. Students will identify criteria for fairness and efficiency and use those criteria to judge the gas tax and the capital gains tax.
This lesson assumes some prior knowledge about what taxes are, and familiarity with some basic types of taxes, including income, property, and sales taxes. Students should also know how regressive, proportional, and progressive taxes work. The Overview of Federal Taxes document provides this background. Additional background, beyond what is provided here, also is available in the Glossary of Common Terms for students unfamiliar with the terms used in this lesson.
In a budget that includes debt service, defense, and social welfare programs as major expenditures, balancing the budget through spending cuts or tax increases alone will be judged by many to be unwise, unfair, and/or untenable.
Taxation has both direct and indirect costs, directly reducing income and some freedom to spend and indirectly affecting markets and distorting incentives.
- The “ideal” tax system is designed to balance the goals of efficiency and equity; an individual’s ideal system will vary based on values and preferences.
BE ABLE TO
Ask good questions and make inferences.
- Support positions with evidence.
- Two Political Cartoons
- Image Annotation Tool for Cartoon A
- Image Annotation Tool for Cartoon B
- Criteria for Evaluating Taxes
- Perspectives and Evidence on the Gasoline Tax
- Perspectives and Evidence on the Capital Gains Tax
- Graphic Organizer: Criteria, Questions, and Evidence
- Overview of Federal Taxes
- Glossary of Common Terms
- Printable PDF of this Lesson
Day 1 of 2
Ask students to discuss what they already know about taxation using Resource 1, Two Political Cartoons, as a trigger to discussing arguments favoring taxation and arguments against too much taxation. Begin by dividing the class in half and distributing Resource 1 to students. One half should receive Cartoon A and the other half Cartoon B. Instruct students to analyze the cartoons. Students who receive Cartoon A should use it to trigger the discussion “Why does society need taxes?” Students who receive Cartoon B should use it to trigger the discussion “Can taxes be harmful to the individual or to the economy?” Tell students to consider what they think the cartoonist is trying to say and how that message fits with what they already know about taxation.
Students should share their cartoons, interpretations, and responses to the trigger questions with one another. The objective is not to debate these questions, but rather to clarify what they know and think. Students should try to challenge, question, and cross-check one another to come to the best possible responses to the two framing questions as a group.
Invite groups to share responses to each of the two questions, encouraging students to cite specific examples and evidence where possible. Record responses on the board or chart paper using a two-column chart, with one column titled “Benefits of Taxation” and the other titled “Costs of Taxation.”
Why does society need taxes? (Cartoon A)
[Student responses will vary, but may include the need to fund essential public goods and services, the desire to balance the budget and avoid deficits and debt, and, based on the cartoon, some desire for equity or fairness by closing loopholes for the wealthy rather than cutting social programs for people who need them.]
Can taxes be harmful to the individual or to the economy? (Cartoon B)
[Student responses will vary. In the cartoon, a Cinderella-like character is getting three wishes taxed. Students might infer that the cartoonist believes this is ridiculous and that “money” is simply being taken from her. Presumably, she will be able to keep only one of the three. If she wished for a fancy horse-drawn carriage, a beautiful dress, and a prince, she would only get one of the three. Emphasize that, with taxation, some costs are direct—the carriage, for example—whereas others are indirect; for example, without a carriage and dress, “Cinderella” won’t get her prince. She’ll indirectly lose “productivity.” She loses the prince and (you might offer this leap), the economy loses whatever she and the prince might have created together—a new kingdom?]
Inform students that they will now need to make decisions as voters on the design of the tax system. They will likely wish to support changes to the tax code that maximize benefits and revenue and minimize costs. To create a framework for making such judgments, students will engage in a simulation based on an idealized scenario in which they will select and prioritize criteria for evaluating the benefits and costs of any given tax. They will then “test-drive” and adjust their criteria based on two concrete examples.
Distribute Resource 2, which describes the idealized scenario and offers suggested criteria from which students may select. Students should read the scenario, add any criteria of their own to the suggestions, and rank what they consider to be the top five most important criteria. Students should then reassemble in groups of four and compare responses, coming to consensus on the three most important criteria. Each group must also provide justification for the criteria it selects.
Once the groups have finalized their criteria, transition to the next activity by leading a discussion on which criteria relate to “fairness,” which relate to “efficiency,” and how students define those terms.
[Student responses and definitions will vary. Encourage diversity of opinions in that there are a multitude of definitions of fairness and differences of opinion on how to best achieve efficiency, which in this context means achieving the highest revenue at minimum cost. Fairness may mean that everyone is treated the same, or pays the same tax, or that those who use services the most pay the most. It could also mean that those who are most able pay the most, because they can afford to or to redistribute wealth. Efficiency might mean that taxes create the right incentives by, for example, putting higher taxes on undesirable things like smoking and lower taxes on desirable things like working. Students should also be encouraged to think about the extent to which these two goals—fairness and efficiency—are compatible, or if they are contradictory/mutually exclusive.]
Examining Evidence and Applying Criteria: Two Case Studies
The groups of four should now split into pairs. To prevent bias for or against each tax carried over from the cartoon activity, each pair should include one student who had Cartoon A and one student who had Cartoon B. Within each group, one pair will receive Resource 3 and examine perspectives and evidence on the user tax on gasoline, and one pair will receive Resource 4 and examine the capital gains tax.
For the remainder of the period and for homework, students should individually read through all of the cartoons, text excerpts, quotations, tables, and graphs contained within the resources. As they read, they should highlight or note whenever there is evidence related to one of their top three criteria selected in the previous activity, and whether that evidence gives information on the fairness of the tax, the efficiency of the tax, or both.
Day 2 of 2
Invite the members of each pair to take 10 minutes to share their findings with one another. Have pairs come to a consensus on what the tax is, and identify evidence they found related to the fairness and efficiency criteria. They should also prepare a quick, 2- to 3-minute summary describing and explaining the tax to the other partnership in their group, providing their initial assessment of whether the tax successfully meets the group’s goals of an ideal tax along with justification for their assessment. After these preparations, the pairs should make brief presentations to each other. The group should then compare and synthesize what it has learned and concluded about the two taxes, using the following scaffolding questions to guide their discussion and ensure comprehension of the resources:
What is the gas tax?
[Students will note that the gas tax is a tax on gasoline paid by users (drivers) at the pump, the point of sale. Currently the federal gas tax is 18.4 cents a gallon, a figure that hasn’t changed since 1993. When state taxes are added in, Americans pay an average of 43 cents per gallon in taxes.]
What is the justification for the gas tax?
[Students should understand that the gas tax supports the Highway Trust Fund. It accounts for 90% of the fund, and lately the Treasury Department has had to add an estimated $72 billion to cover expenses and deal with a backlog of repairs on bridges and roads. The tax also encourages consumers to buy fuel-efficient cars, which are better for the environment.]
Why are some people opposed to the gas tax?
[Opponents to the gas tax view it as money taken from the driver’s pocket and not necessarily used in efficient ways. In particular, opponents might argue that it is particularly inappropriate during a recessionary period when consumers have less money to spend.]
How does the gas tax in the United States compare to gas taxes in other countries?
[Students will notice that the gas tax is about 50% less in the United States than it is in at least seven European countries.]
What are capital gains?
[Capital gains is money that is earned on investments and is often referred to as making money on money. These investments not only earn money for the investor, but also provide capital for projects and businesses, some of which are drivers of economic growth.]
What does it mean that the tax system is progressive? What is the justification for that?
[The tax system is progressive because people who earn more money are taxed at a higher rate than those who earn less. The formulation is based on money earned over a series of income brackets, and the justification is two-fold. A progressive income tax takes more money from those who are most able to afford it, and it has a moderating effect on income disparity.]
Why is the capital gains tax an exception to how progressive the tax system is? What is the reason for the exception?
[Capital gains are taxed at a lower rate than regular income. Those in favor of this lower rate say that it is good for the economy because it enables the investment of capital in productive projects. An investor can pull money out of a company that is not successful and put it into one that is successful without the deterrence of a higher tax rate. They also argue that this money is already taxed because the income corporations earn is taxed. Those opposed to this lower tax rate argue that experience has shown that a higher rate of taxation on capital gains (as high as 30% between 1986 and 1997) does not discourage investment. They also argue that it deprives the country of needed revenue and contributes to income inequality because very wealthy people earn a large percentage of their money in this way. In addition, corporations have access to so many tax loopholes that, in practice, do not offset low capital gains tax.]
Revising Criteria, Asking Questions, and Seeking Evidence
Distribute Resource 5, which asks students to reassess their initial criteria. Groups should consider whether the priorities selected on day 1 have changed, and discuss why. Then, they should fill in the criteria, whether or not they have been revised. For each criterion and each tax, students should consider what questions they have and what additional economic evidence they would seek for better assessment. Inform students that this will serve as their final recommendation to Congress.
Inform students that the current gas tax is 18.4 cents a gallon, and the current maximum capital gains tax is 15%. Without discussion, ask students to write on a piece of paper what their “gut feeling” on these taxes is—should they be raised, lowered, or kept about the same? In order to preserve the independence of their judgments, ask students to hide their answers, perhaps by folding their paper. Poll student responses and then ask for volunteers to defend their answers. Ask students who have not responded what more they would want to know to fully support their opinions. For homework, students should draft a letter to the Congressional Ways and Means committee summarizing their recommendations for how to further study these two important taxes. Tell students to account for the best of their classmates’ reasoning in making their recommendations.
Common Core State Standards (CCSS) Initiative
CCSS.ELA-Literacy.RI.11-12.7. Integrate and evaluate multiple sources of information presented in different media or formats (e.g., visually, quantitatively) as well as in words in order to address a question or solve a problem.
CCSS.ELA-Literacy.RH.9-10.7. Integrate quantitative or technical analysis (e.g., charts, research data) with qualitative analysis in print or digital text.
CCSS.ELA-Literacy.RH.11-12.8. Evaluate an author’s premises, claims, and evidence by corroborating or challenging them with other information.
The College, Career, and Civic Life (C3) Framework for Social Studies State Standards
D2.Eco.6.9-12. Generate possible explanations for a government role in markets when market inefficiencies exist.
D2.Eco.8.9-12. Describe the possible consequences, both intended and unintended, of government policies to improve market outcomes.
Americans for Tax Reform. (n.d.). Taxpayer protection pledge. Retrieved from http://www.atr.org/take-the-pledge
Bendib, K. (2011, April 4). Where will we find the money? Retrieved from http://www.otherwords.org/tax-the-rich-cartoon
Buffet, W. (2011, August 14). Stop coddling the super-rich. New York Times. Retrieved from http://www.nytimes.com/2011/08/15/opinion/stop-coddling-the-super-rich.html?_r=1
Congressional Budget Office. (2008, December 23). Historical effective tax rates, 1979 to 2005: Supplement with additional data on sources of income and high-income households. Retrieved from http://www.cbo.gov/publication/20374
DF. (2012, February 4). Eliminate federal gas taxes [Web log comment]. Retrieved from http://www.redstate.com/whatevrworks/2011/02/04/eliminate-federal-gas-taxes/
Forbes, S., & Ames, E. (2009). How capitalism will save us. New York: Crown.
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Luckovich, M. (1993, January 26). The gas tax. Creators Syndicate. Retrieved from http://www.panix.com/~danielc/usa/dragon.htm
Mankiw, N. G. (2009). Smart taxes: An open invitation to join the Pigou club. Eastern Economic Journal, 35, 14–23. Retrieved from http://scholar.harvard.edu/files/mankiw/files/smart_taxes.pdf
Martin, G. (2012). Nothing is certain but death and taxes. Retrieved from http://www.phrases.org.uk/meanings/death-and-taxes.html
Randall, T. (2015, September 10). The real cost of filling up: Gasoline prices by country. Bloomberg. Retrieved from http://www.bloomberg.com/graphics/gas-prices/
Reich, R. (2011, April 4). Why we must raise taxes on the rich. Huffington Post. Retrieved from http://www.huffingtonpost.com/robert-reich/why-we-must-raise-taxes-o_b_844606.html
Saunders, L. (2015, April 10). Top 24% of earners pay 84% of income tax. Wall Street Journal. Retrieved from http://www.wsj.com/articles/top-20-of-earners-pay-84-of-income-tax-1428674384
Warbiany, B. (2005, September 23). Taxes as behavior modification [Web log comment]. Retrieved from http://www.fairtaxblog.com/20050923/taxes-as-behavior-modification/
Explore other types of taxation (carbon taxes, consumption vs. income tax, flat tax proposals, etc.). This can include critically evaluating tax reform proposals by 2016 presidential candidates.
Depending on where this lesson fits into an economics curriculum, there are several extension and application opportunities that more explicitly connect this material with microeconomic and macroeconomic theory. Examples include:
If this lesson is used as part of a unit on the price elasticity of supply and demand, students can be encouraged to seek evidence on how production and consumption of gasoline vary by state and how they have changed over time as states have raised and lowered their gas taxes. This can help illustrate how elasticity determines the incidence of a tax.
Students can be encouraged to draw graphs predicting what would happen if an excise tax, such as the gasoline tax, were raised or lowered, labeling supply curve, demand curve, producer surplus, consumer surplus, tax revenue, and deadweight loss.
- Students with some background in macroeconomics can be encouraged to think about taxation as a tool of fiscal policy. In particular, they should compare the effects of cutting taxes to those of increasing government spending, consider the tax and spending multipliers, and use this analysis to further explore the effects of capital gains taxes on investments and long-run growth.