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Chapter 7: Problem 13

Each of the following tax proposals has income as the tax base. In each case, calculate the marginal tax rate for each level of income. Then calculate the percentage of income paid in taxes for an individual with a pre-tax income of \(\$ 5,000\) and for an individual with a pre-tax income of \(\$ 40,000 .\) Classify the tax as being proportional, progressive, or regressive. (Hint: You can calculate the marginal tax rate as the percentage of an additional \(\$ 1\) in income that is taxed away.)a. All income is taxed at \(20 \%\). b. All income up to \(\$ 10,000\) is tax-free. All income above \(\$ 10,000\) is taxed at a constant rate of \(20 \%\). c. All income between \(\$ 0\) and \(\$ 10,000\) is taxed at \(10 \%\). All income between \(\$ 10,000\) and \(\$ 20,000\) is taxed at \(20 \%\). All income higher than \(\$ 20,000\) is taxed at \(30 \%\). d. Each individual who earns more than \(\$ 10,000\) pays a lump-sum tax of $\$ 10,000\(. If the individual's income is less than \)\$ 10,000$, that individual pays in taxes exactly what his or her income is. e. Of the four tax policies, which is likely to cause the worst incentive problems? Explain.

Short Answer

Expert verified
Answer: For Tax Proposal a, with constant rate of 20%, the marginal tax rate is 20% for both incomes. The percentage of income paid in taxes for $5,000 and $40,000 is both 20%. This tax is proportional. For Tax Proposal b, with 0% tax on income up to $10,000 and 20% on income above $10,000, the marginal tax rate is 0% for $5,000 and 20% for $40,000. The percentage of income paid in taxes for $5,000 is 0% and for $40,000 is 15%. This tax is progressive. For Tax Proposal c, with marginal tax rates of 10%, 20%, and 30% for different income brackets, the marginal tax rate is 10% for $5,000 and 30% for $40,000. The percentage of income paid in taxes for $5,000 is 10% and for $40,000 is 25%. This tax is progressive. For Tax Proposal d, with a marginal tax rate of 100% for incomes below $10,000 and 0% for incomes above $10,000, the marginal tax rate is 100% for $5,000 and 0% for $40,000. The percentage of income paid in taxes for $5,000 is 100% and for $40,000 is 25%. This tax is regressive. The tax policy with the worst incentive problems is Tax Proposal d, as it creates disincentives for low-income individuals to work and might increase inequality.

Step by step solution

01

Calculation for Tax Proposal a.

All income is taxed at a constant rate of \(20\%\). Therefore, the marginal tax rate is also \(20\%\).
02

Calculation for Tax Proposal b.

There are two income brackets here - income up to \(10,000 (tax-free), and income above \)10,000 (taxed at \(20\%)\). The marginal tax rate for income up to \(10,000 is \)0\%\(. For income above \)10,000, the marginal tax rate is \(20\%\).
03

Calculation for Tax Proposal c.

There are three income brackets - between \(0\) and \(10,000 (taxed at \)10\%)\(, between \)10,000\( and \)20,000 (taxed at \(20\%)\), and higher than \(20,000 (taxed at \)30\%)\(. The marginal tax rates are \)10\%\(, \)20\%\(, and \)30\%$ respectively for the three income brackets.
04

Calculation for Tax Proposal d.

For individuals earning more than \(10,000, they pay a lump-sum tax of \)10,000\(. Those with income below \)10,000 pay taxes equal to their income. The marginal tax rate is \(100\%\) for incomes below \(10,000 and \)0\%\( for incomes above \)10,000. #Phase 2: Calculating the Percentage of Income Paid in Taxes#
05

Calculating for Tax Proposal a.

With a pre-tax income of \(5,000, an individual would pay \)5,000 * 0.2 = \(1,000 in taxes. The percentage of income paid in taxes would be \)\frac{1,000}{5,000} * 100 = 20\%\(. For an individual with a pre-tax income of \)40,000, they would pay \(40,000 * 0.2 = \)8,000 in taxes. The percentage of income paid in taxes would be \(\frac{8,000}{40,000} * 100 = 20\%\). This tax is proportional.
06

Calculating for Tax Proposal b.

With a pre-tax income of \(5,000, an individual would pay no taxes, because the income is below \)10,000. The percentage of income paid in taxes is \(0\%\). For an individual with a pre-tax income of \(40,000, they would pay taxes on \)30,000 (income above \(10,000), which is \)30,000 * 0.2 = \(6,000. The percentage of income paid in taxes would be \)\frac{6,000}{40,000} * 100 = 15\%$. This tax is progressive.
07

Calculating for Tax Proposal c.

With a pre-tax income of \(5,000, an individual would pay \)5,000 * 0.1 = \(500 in taxes. The percentage of income paid in taxes would be \)\frac{500}{5,000} * 100 = 10\%\(. For an individual with a pre-tax income of \)40,000, they would pay taxes as follows: \(10,000 * 0.1 = \)1,000 for the first bracket, and \(30,000 * 0.3 = \)9,000 for the third bracket. The total taxes paid would be \(1,000 + \)9,000 = \(10,000. The percentage of income paid in taxes would be \)\frac{10,000}{40,000} * 100 = 25\%$. This tax is progressive.
08

Calculating for Tax Proposal d.

With a pre-tax income of \(5,000, an individual would pay \)5,000 in taxes. The percentage of income paid in taxes would be \(\frac{5,000}{5,000} * 100 = 100\%\). For an individual with a pre-tax income of \(40,000, they would pay a lump-sum tax of \)10,000. The percentage of income paid in taxes would be \(\frac{10,000}{40,000} * 100 = 25\%\). This tax is regressive.
09

Tax Policy with Worst Incentive Problems

Tax proposal d is likely to cause the worst incentive problems. For individuals earning below \(10,000, the tax rate is \)100\%\(, which might disincentivize them from working. On the other hand, people with income above \)10,000 have no marginal tax rate, incentivizing them to earn more without paying additional taxes. This might lead to work disincentives for low-income individuals and increased inequality.

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Most popular questions from this chapter

The state needs to raise money, and the governor has a choice of imposing an excise tax of the same amount on one of two previously untaxed goods: the state can tax sales of either restaurant meals or gasoline. Both the demand for and the supply of restaurant meals are more elastic than the demand for and the supply of gasoline. If the governor wants to minimize the deadweight loss caused by the tax, which good should be taxed? For each good, draw a diagram that illustrates the deadweight loss from taxation.

All states impose excise taxes on gasoline. According to data from the Federal Highway Administration, the state of California imposes an excise tax of $\$ 0.40$ per gallon of gasoline. In 2013, gasoline sales in California totaled 18.4 billion gallons. What was California's tax revenue from the gasoline excise tax? If California doubled the excise tax, would tax revenue double? Why or why not?

The U.S. government would like to help the Americar auto industry compete against foreign automaker: that sell trucks in the United States. It can do this by imposing an excise tax on each foreign truck sold in the United States. The hypothetical pre-tax demand anc supply schedules for imported trucks are given in the accompanying table. a. In the absence of government interference, what is the equilibrium price of an imported truck? The equilibrium quantity? Illustrate with a diagram. b. Assume that the government imposes an excise tax of \(\$ 3,000\) per imported truck. Illustrate the effect of this excise tax in your diagram from part a. How many imported trucks are now purchased and at what price? How much does the foreign automaker receive per truck? c. Calculate the government revenue raised by the excise tax in part b. Illustrate it on your diagram. d. How does the excise tax on imported trucks benefit American automakers? Whom does it hurt? How does inefficiency arise from this government policy?

The United States imposes an excise tax on the sale of domestic airline tickets. Let's assume that in 2013 the total excise tax was \(\$ 6.10\) per airline ticket (consisting of the \(\$ 3.60\) flight segment tax plus the $\$ 2.50$ September 11 fee). According to data from the Bureau of Transportation Statistics, in 2013, 643 million passengers traveled on domestic airline trips at an average price of \(\$ 380\) per trip. The accompanying table shows the supply and demand schedules for airline trips. The quantity demanded at the average price of \(\$ 380\) is actual data; the rest is hypothetical. a. What is the government tax revenue in 2013 from the excise tax? b. On January 1, 2014, the total excise tax increased to \(\$ 6.20\) per ticket. What is the quantity of tickets transacted now? What is the average ticket price now? What is the 2014 government tax revenue? c. Does this increase in the excise tax increase or decrease government tax revenue?

Assess the following four tax policies in terms of the benefits principle versus the ability-to-pay principle. a. A tax on gasoline that finances maintenance of state roads b. An \(8 \%\) tax on imported goods valued in excess of \(\$ 800\) per household brought in on passenger flights c. Airline-flight landing fees that pay for air traffic control d. A reduction in the amount of income tax paid based on the number of dependent children in the household.
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