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Financial Literacy

Financial Literacy

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The Purpose of Taxes

Even with Adam Smith’s principles for how taxes should be levied and collected, there still remains the question about the purpose of our tax dollars. Is everyone just partying it up out there in Washington, on us?

The three main purposes of tax dollars in America are:

o To provide a revenue stream for government
o To redistribute wealth from the rich to the poor (see Hood, Robin)
o To avoid negative externalities (unintended bad results)

First and foremost, tax dollars are used to fund government spending, whether that is to keep us safe, build schools, or make Medicare payments. They are also used to redistribute wealth in order to maintain a level of equality in society. If you stick your head out your window right now, you can just breathe in all that equality. Ahhhh.

The government believes that by taxing the wealthy and distributing wealth to the less fortunate, America will have a more stable society and be able to maintain its relatively large middle class. (And note: There are more poor voters than wealthy ones.)

America’s recent history has proven that to be the case and could be one of the reasons for America’s disproportionate prosperity over the past 100 years (if it’s not broke, don’t fix it).

But now that the middle class has been steadily shrinking for years, we have to ask…is it broke? What broke it? Can we blame China? Would we ever put prisoners to work for a buck a day to compete with foreign importers who have different (is that what we call it?) views on human rights?

This is a controversial argument. The Obama Administration would like to tax the top 2% more and distribute wealth to others. The other side argues that the top 1% already pay 40% of taxes.

In addition, according to Arthur Laffer, among others, people change their behavior if you tax them more. They will work less or change the way they receive income to avoid taxes.

Negative Externalities: Every time you use a gallon of gas in your car or dump your old computer parts in the trash, you release toxins into the air and ground, which affects everyone in society. It even affects those not in our society. We’re looking at you, fish and birds.

As a result, the government chooses to tax things like gas and electronics and then uses the funds to mitigate the harmful effects on society. Unless, of course, there is an administration in place that tends to view Global Warming as nothing more than a “stubborn heat wave.”

Taxes on their own create negative externalities because they change behavior and make the market less efficient. Whenever a tax is imposed, both the producer and the consumer bear part of it. The end result is an economic concept called deadweight loss, which, despite its name, is not a zombie fitness plan.

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