How the tax rates are determined by governments?


I would assume that governments estimate the amount of extra money they need to finance public healthcare, pensions, infrastructure improvements, etc. They make the projection for the coming years, add some safety gap on top and then calculate the tax rate based on this required amount of extra income. Is that true?

If so, such calculation leads us to a flat tax rate. If we are talking about a progressive tax, how are the decisions about tax bands and rates for each band made?

In: 1

You’d be wrong.

The legislature gets input from economic calculations, in the US from the Congressional Budget Office, but more often than not the numbers are chosen to send political messages.

There are very, very few flat tax systems. Almost all systems are extremely progressive, what’s the point of collecting taxes from some poor person who you make social safety net payments to? That would just be government using taxes to collect its own money. Tax bands are set politically, trading off the influence of the rich with the influence of the anti-rich. (poor ≠ anti-rich) Poor people have little money; whereas anti-rich people don’t want other people to have as much money as they already have.

That’s to some extent true, but there’s more to it.

They also do analysis of what impact the taxes will have on the economy, it may raise or lower GDP, employment, consumption etc…and try to figure out the net impact of it.

Also they wouldn’t just stop at a flat tax, part of the analysis would be which tax brackets are affected by what and what revenue would come from who.

There’s also then all the extra things like incentives for certain things, deductions, credits etc…

The tax bands are usually then done by percentiles and they try to have kind of a smooth curve and any time they adjust they obviously look at what the current tax rates are already.

They’d also consider state and sales taxes, cost of living etc… there’s a lot that goes into it, and they don’t just match expenses to revenues, there’s of course the option to increase the debt, or lower it with a surplus.

On top of all that is just the political considerations, what’ll get votes, what will serve donors etc..

Although this sounds logical, in real life, it seldom works that way. Tax rates and tax policy are rarely revised annually. In many cases, these things are a massive political effort, big industries, significant industrial sectors (defense etc), labor unions, political parties are engaged. For example, the marginal income tax rates might be fixed for many years (or decades) if there isn’t political will to change things. Tax rates are always a mix of revenue goals, political aims and an exercise of various powers in the country.

Governments almost always have annual budgeting exercises, where they allocate spending and funding for programs. In some countries there are laws that require balanced budgets or limit the spending in some ways. In others things are not spelt out so clearly and governments will/can balance their books by borrowing.

What you describe is more along lines of how local property taxes are calculated… figure out budget amount needed and then divide by assessed valuations. Income taxes are more estimates, and the federal government can also issue bonds (debt) to cover shortfalls in revenue (while increasing the overall debt with the deficit spending)

in texas that is exactly how property taxes work. The taxing district determines the value of all properties. Each taxing entity (city, school district, county etc) determine their budgets. Then they set a tax rate that raises the money the budget requires. The property tax rate fluctuates every year. As the value of housing rapidly increases the tax rate often goes down even as budgets increase.

State and federal govt dont do this. Tax rates dont change often and are simply set by laws. Instead the federal government sells debt (treasury bonds) to raise funds and the federal reserve and government agencies like the social security administration buy that debt.

State governments can also sell debt, but they tend to be somewhat more fiscally responsible because they cant just print money to pay their debts.