Types of Taxes & the US Tax Code: Impact on Microeconomics

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  • 0:01 Taxes for Microeconomists
  • 1:40 Types of Tax Structures
  • 3:40 Taxes in the United States
  • 6:00 Lesson Summary
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Lesson Transcript
Instructor: Kevin Newton

Kevin has edited encyclopedias, taught history, and has an MA in Islamic law/finance. He has since founded his own financial advice firm, Newton Analytical.

I know what you're thinking - it's bad enough I have to pay taxes, now why would I want to sit through a lesson on them. However, understanding more about taxes may help you convince the government that you don't need so many of them...

Taxes for Microeconomists

Sadly, taxes are a way of life for all of us. However, microeconomists have to think about taxes much more than the rest of us. No, this isn't because the government has some special hatred of microeconomics. Instead, it's because taxes change a great deal of the microeconomic landscape. This is because taxes change prices.

While that sounds like a simple enough statement, it has massive implications. By now, you're probably pretty familiar with the relationship between demand and price. In short, the two have an inverse relationship - the higher the price, the lower the demand. Since taxes are just tacked onto the cost of something, this causes the price to rise. This shrinks demand, which means that suppliers supply less, meaning that, in turn, they don't have to have as many jobs. This is why having enormous tax rates is such an economically touchy subject.

Oh, and before you think that it's just a tax on suppliers, don't think for a second that those producers aren't passing the cost on to you, the consumer. Think about it - if you live on a state border between a state that has a high sales tax and another state that has no sales tax, which one are you going to frequent when you have to purchase something? By shopping in a lower-tax jurisdiction, you could save several percent on your overall purchase.

Types of Tax Structures

Of course, there are multiple ways of taxing a population. There are three major styles of taxation. These are proportional, progressive, and regressive. We'll start with regressive first, since it's the rarest. That doesn't mean by any means that it is uncommon, however. Ever bought a lottery ticket? Chances are you didn't see many CEOs lining up to play the lottery. Instead, statistics show that people with less economic resources tend to play the lottery more heavily. And what does that money typically support? Education. That's right - the lottery is just a really clever tax.

In fact, it's called a regressive tax because it charges those at lower income levels a higher portion of their income. The exact opposite of this is called a progressive tax, which charges higher percentages of income for each step up in income a person makes. This is what the United States and many other countries use as the basis for their income taxes, because it aims to spread the burden with a greater eye towards ability to pay. For example, in the U.S., the lowest tax bracket is 10%. The highest tax bracket is almost 40%, but that is only on income over more than $400,000 a year. We'll talk more about that in a few minutes.

The final type of taxes are proportional taxes. As you might expect from the name, these taxes are levied at a set proportion of the amount to be taxed. Most frequently, these are used as sales taxes, such as the Value Added Tax in Europe. Occasionally, you will see people argue for a flat tax in the United States - what they really want is a proportional tax.

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