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Taxes: You’ve Got to Hand it to Them

Notes to the instructor

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This is an opportunity for a discussion to find out what the students already know about taxes. Adult learners will be all too familiar with tax returns, but younger students may not have any experience.

Students may have a stereotype about who evades taxes. These videos cover a range of people:

Here is a politician in trouble for tax evasion:
http://newyork.newsday.com/westchester/nick-spano-to-be-sentenced-today-for-tax-evasion-1.3787500

This person describes a pop musician who didn’t pay income tax:
http://www.youtube.com/watch?v=ZwZklco1hso

Here is the sentencing of a businessman who under reported sales tax to the government:
http://video.agaclip.com/w=8i7_9QAz47n

Sentencing a tax evader mom in Iowa. Beware the blog!
http://www.crownheights.info/index.php?itemid=34726

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Be sure students understand the difference between "filing" and "paying."

Definition of 'Tax Return' from investopedia

1. The tax form or forms used to file income taxes with the Internal Revenue Service (IRS). Tax returns often are set up in a worksheet format, where the income figures used to calculate the tax liability are written into the documents themselves. Tax returns must be filed every year for an individual or  business that received income during the year, whether through regular income (wages), interest, dividends, capital gains, or other profits.

Suppose you don’t have enough money to pay what you owe at filing time. What is more expensive, waiting a month to file and pay, or filing on time and then waiting a month to pay?

This describes possible options if you are late or can’t afford the full amount:
http://www.irs.gov/businesses/small/article/0,,id=108326,00.html

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You can make up many more math problems of this sort. But you should also note that the IRS will file a return for you if you fail to file.

From the IRS web site:

It's important to understand the ramifications of not filing a past due return and the steps that the IRS will take. Taxpayers who don't file a past due return or contact the IRS are subject to the following:

A good discussion question is: what are the other sources the IRS uses to get information about your income? Look at the "How Much Will I Take Home?" module for a discussion of what is on your pay stub. The government, of course, can get this information.

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It might be good to have a short discussion of the consequences of bad credit. Here is a short explanation:

http://www.youtube.com/watch?v=EQsmu_AaM2E

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Who makes money off all of these rules? And who made them? And why are there so many? What is a "loophole?" These are good discussion/research questions, and could easily lead to short written assignments.

It is useful, however, to point out that the less money you make, the simpler the rules actually are for what to pay, how to pay, and how to file a return.

Federal tax rule image:
http://www.cato-at-liberty.org/federal-tax-rules-72536-pages/

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Taken from http://taxes.about.com/od/Federal-Income-Taxes/qt/Tax-Rates-For-The-2012-Tax-Year.htm

Here is the real math problem. It would be good to have many groups of students calculate federal taxes on a variety of incomes with varying filing status. Are there circumstances in which it is better for married couples to file separately? Etcetera.

You can also use this spreadsheet to do the same calculation. But it's good to do a few by hand before experimenting with different scenarios on the spreadsheet.

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This is a model for student work. Go over it slowly.

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Here is an excellent opportunity for graph literacy. After staring at this chart, students can make new ones for different years by looking up data and using this free tool.

Here are some discussion/research/writing questions.

  1. What does "non-defense discretionary" mean?
  2. What fraction of the population is supported by the social security tax?
  3. What fraction of the population benefits from Medicare/Medicaid?
  4. Is it cheaper to pay the Social Security/Medicare/Medicaid tax over a lifetime or is it cheaper to support your parents in their old age and provide their health insurance?

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Challenge students to complete this list in advance of the following slides.

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How does Wyoming pay for road repair? Schools? Road plowing? Libraries? Colleges? The police and fire department?

Any state that doesn’t collect an income tax must find other ways to pay for basic services.

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It's Paul Revere.

Statue of Paul Revere by Cyrus E. Dallin, in the Paul Revere Mall, North End, Boston, Massachusetts. Photograph taken by Daderot, September 2005.

It was about taxation without representation. Not just taxation.

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Here is a research problem. Each of the states with no income tax has a way to fund basic services. Compare/contrast two states in this category. There are 9, for a total of 36 possible research topics.

If Professor Nutshell wants to assign all 50 students a research topic of this sort, and asks each student to compare a different set of 3 states, will she have enough topics?

Another way to look at this data is in terms of state income. The 4% of income collected by West Virginia amounts to how much money? What would the total income of WV residents be? What fraction of the WV state budget is covered by this amount? And so forth . . .

And as for reading the bar chart, what percent of states have an income tax of more than 5%?

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Usually something like a house is held for quite a while. But stocks can be bought and sold easily, so the government makes a distinction between “long term” and “short term” capital gains.

A brief explanation can be found here:
http://taxes.about.com/od/capitalgains/a/CapitalGainsTax_4.htm

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If you haven't already had this discussion, now would be a good time to have students consider these questions for discussion/research/writing.

What fraction of the population is supported by the social security tax? What fraction of the population benefits from Medicare/Medicaid? Is it cheaper to pay the Social Security/Medicare/Medicaid tax over a lifetime or is it cheaper to support your parents in their old age and provide their health insurance?

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This chart is a good exercise in reading graphs. What do the various percents represent? There are two different quantities represented by percents here.

And the bars are “nested” in that people are counted multiple times. So the percents represented by the bar length sum to more than 100.

What percent of the elderly population relies on social security for less than 50% of their income?

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Ask the students to put the meaning of this graph into words.

A history of social security is here:
http://www.ssa.gov/history/briefhistory3.html

It is often pointed out that social security benefits were never supposed to be the sole source of income for the elderly. Do the two bar charts suggest that this is the case?

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Who is picking up more of the bill, the employee or the employer?

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This pie chart describes federal spending. But states also have social services, and students can look up similar charts for any state and compare how they spend their resources.

Here, for example, is Michigan:
http://www.michiganpolicy.com/index.php?option=com_content&view=article&id=355:state-budget-an-overview&catid=31:state-budget-policy-briefs&Itemid=96

Here you can find sales tax by state and county 1999-2011: The Sales Tax Clearing House:
 http://thestc.com/STrates.stm

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What do students make of the slight uptick on the right side of this graph?

What amounts of income total are represented by each bar? That is, out of a hundred people, 16% are making 0 to $10,000, for a total amount of 0 to $160,000 dollars. Is this more or less than than the 3% of highest earners? Students can make various assumptions and create pie charts of how income is distributed across wage classes.

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Here you can find sales tax by state and county 1999-2011: The Sales Tax Clearing House.

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So if you are self-employed in a particular state, you can calculate your total tax liability from federal and state taxes. Have students do this for a few states and compare. You can estimate taxes using the “estimated tax for individuals” form available at http://www.irs.gov/businesses/small/article/0,,id=110413,00.html

Students can compare what happens with different status. And especially they can compare the usual tax rate with what happens to the self-employed.

One could have a profitable conversation as to why an independent plumber would charge $200 per hour for their services.

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Returning to slide 18, which says:

Employee/Employer

  • The Social Security tax rate for employees is 4.2 percent through the end of the year
  • The Social Security tax rate for employers is 6.2 percent
  • The Medicare tax rate is 1.45 percent for both employees and employers

If you are self-employed, what percent of income must go to social security?

A similar calculation holds for the other taxes as well.

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Have students try to foresee what will go wrong.

If you make $5000 on each of two jobs, what will your two employers withhold and send to the government?

What will be your tax liability for the year?

What will you owe the IRS at tax time?

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Slide 1 had a discussion of what happens when you don’t pay your taxes. This slide is an example of how that can happen.

Can students think of other ways in which a person might accidentally underpay their taxes?

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Tax preparers are fond of pointing out that a small deduction can make a big difference in your tax if it causes the adjusted gross income to fall below one of the cutoffs for a marginal tax rate. Have students figure out some scenarios, using the spreadsheet, for which this would be the case.

Here is a good place to have a discussion of the phrase "pre-tax dollars." If you put $100 into your tax sheltered retirement account, how much will you have to earn to put $100 into a regular account? (It depends on your income!)

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Other states will have different pie charts, with various kinds of taxes not in this chart.

Some amusing examples include the gas tax:



And the soda tax:



There is the possibility here for students to investigate various luxury taxes and forms they have taken throughout history.

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This video explicitly describes the subway fare as a tax. You don’t usually think of subway fare as a tax, do you?

This is the classic 1959 Kingston Trio hit commemorating a rise in the subway tax. Jacqueline Steiner and Bess Lomax Hawes wrote the song in 1949 as a campaign song for the progressive party candidate Walter A. O’Brian. The candidate’s name was changed for the Kingston trio version. For more history see:  http://en.wikipedia.org/wiki/M.T.A.

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Here is a chance to learn some probability. A short betting game with dice might be a good way to introduce lotteries. Now just imagine the die has 200 million sides.

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It would be interesting for students to do a comparative study of lottery income by state, and how it is spent. Is the lottery a good idea?

Here is the census data from 2010:
http://www.census.gov/govs/state/10lottery.html

Another interesting study would be to look at the economic impact of the right of Native American Nations to run gambling operations. This is a major source of income for these groups.
http://en.wikipedia.org/wiki/Native_American_gambling_enterprises

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Here is a cheap lesson in expected value. What gives a better rate of return after 5 years,

$100 of pre-tax earnings, minus taxes due, used to purchase lottery tickets, with an expected payoff of 50 cents for every one dollar lottery ticket purchased, and taxes due at 25% on the winnings, which are then invested in a mutual fund earning 4% per year?

or

$100 in a tax sheltered retirement fund earning 4% per year?

This is a trick question because you actually lose money on the lottery on average, and you can deduct your loss.

http://www.fool.com/School/Taxes/1998/taxes980710.htm

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If you want to tie this module to issues of savings the tax refund is a natural place to have such a discussion. You can also have your students play Refund Rush, a tax refund game where the player has to decide how various clients should split their refunds to achieve goals. Refund Rush Game: http://financialentertainment.org/node/128

A HARD PROBLEM
If you want a more in-depth estimation problem that will

  1. force students to make assumptions, with differing results for different assumptions
  2. help them review all the types of taxes discussed in this module

Try the following:

How many times does money have to change hands before 90% of it returns to the government? This is an interesting estimation problem. It might not be so hard to do if you imagine money passing from one middle class self employed person to another.

Here is how this might play out under one set of assumptions:

For a self employed person making $125,000, the tax rate (from the estimated tax form 1040-ES from 2012) is almost 50%. Students could take a fake dollar bill and exchange it, cutting half off every time, to see how long it takes before 90% or more is returned to the government. And that is only federal tax. This is what would happen if everyone was self-employed and spent all their money on hiring other self-employed people with the same level of income.

What happens if everyone is much poorer but otherwise the situation remains the same? What if some of the money is spent in other ways, such as purchases subject to sales tax? What happens when people save?

This problem (and its various estimated solutions) could inform a general discussion of economics. How does the government benefit from a strong economy? From thrifty citizens who save their money? From spendthrifts who increase the flow of money through the economy?