Log out Go to App
Go to App

Learning Materials

Features

Discover

Chapter 7: Problem 15

You work for the Council of Economic Advisers, providing economic advice to the White House. The president wants to overhaul the income tax system and asks your advice. Suppose that the current income tax system consists of a proportional tax of \(10 \%\) on all income and that there is one person in the country who earns \(\$ 110\) million; everyone else earns less than \(\$ 100\) million. The president proposes a tax cut targeted at the very rich so that the new tax system would consist of a proportional tax of \(10 \%\) on all income up to \(\$ 100\) million and a marginal tax rate of \(0 \%\) (no tax) on income above \(\$ 100\) million. You are asked to evaluate this tax proposal. a. For incomes of \(\$ 100\) million or less, is this proposed tax system progressive, regressive, or proportional? For incomes of more than \(\$ 100\) million? Explain. b. Would this tax system create more or less tax revenue, other things equal? Is this tax system more or less efficient than the current tax system? Explain.

Short Answer

Expert verified
#Answer# Based on the steps in the analysis, for incomes of 100 million or less, the tax system is proportional. For incomes above 100 million, the tax system is regressive. The new tax system generates less revenue than the current tax system. In terms of efficiency, the new tax system can be considered less efficient, as it generates lower revenue and may promote income inequality.

Step by step solution

01

Understand the terms progressive, regressive, and proportional tax systems

Progressive tax system: A system where the tax rate increases as the taxable income increases. Regressive tax system: A system where the tax rate decreases as the taxable income increases. Proportional tax system: A system where the tax rate remains constant regardless of the taxable income.
02

Determine the tax system for incomes of \(100\) million or less and for incomes above \(100\) million

For incomes of \(100\) million or less, the proposed tax system remains unchanged, with a proportional tax of \(10\%\) on all income. So, for this income range, the tax system is proportional. For incomes above \(100\) million, the marginal tax rate is \(0 \%\) on the income exceeding \(100\) million. This introduces a regressive aspect, as the effective average tax rate decreases for individuals with higher incomes.
03

Evaluate the tax revenue generated by the proposed tax system compared to the current tax system

Under the current tax system, the person with an income of \(110\) million pays \(10\%\) tax on the whole amount, which is \(11\) million in taxes. With the new tax system, the person with an income of \(110\) million pays \(10\%\) tax on the first \(100\) million, yielding \(10\) million in taxes, and no tax on the income above \(100\) million. All other individuals earning less than \(100\) million are not affected by the tax change. So, the tax revenue generated by the proposed tax system is \(1\) million less than the revenue generated under the current tax system.
04

Analyze the efficiency of the proposed tax system compared to the current tax system

Efficiency, in this context, refers to the tax system's ability to generate revenue and minimize distortions in the economy. By reducing the tax revenue, the new system is less efficient in generating revenue than the current tax system. Regarding economic distortions, the proposed tax system can encourage individuals to increase their income above the \(100\) million threshold, which may stimulate economic growth. However, it also can lead to income inequality as wealthy individuals accumulate more wealth due to lower tax rates, which can undermine the society's overall well-being. Thus, the efficiency of the new tax system compared to the current one is debatable, depending on other factors in the economy. Overall, it can be considered less efficient since it generates less revenue and introduces income inequality.

Unlock Step-by-Step Solutions & Ace Your Exams!

  • Full Textbook Solutions

    Get detailed explanations and key concepts

  • Unlimited Al creation

    Al flashcards, explanations, exams and more...

  • Ads-free access

    To over 500 millions flashcards

  • Money-back guarantee

    We refund you if you fail your exam.

Start your free trial

Over 30 million students worldwide already upgrade their learning with Vaia!

One App. One Place for Learning.

All the tools & learning materials you need for study success - in one app.

Get started for free

Most popular questions from this chapter

In Transylvania the basic income tax system is fairly simple. The first 40,000 sylvers (the official currency of Transylvania) earned each year are free of income tax. Any additional income is taxed at a rate of \(25 \% .\) In addition, every individual pays a social security tax, which is calculated as follows: all income up to 80,000 sylvers is taxed at an additional \(20 \%\), but there is no additional social security tax on income above 80,000 sylvers. a. Calculate the marginal tax rates (including income tax and social security tax) for Transylvanians with the following levels of income: 20,000 sylvers, 40,000 sylvers, and 80,000 sylvers. (Hint: You can calculate the marginal tax rate as the percentage of an additional 1 sylver in income that is taxed away.) b. Is the income tax in Transylvania progressive, regressive, or proportional? Is the social security tax progressive, regressive, or proportional? c. Which income group's incentives are most adversely affected by the combined income and social security tax systems?

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.

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.

In each of the following cases involving taxes, explain: (i) whether the incidence of the tax falls more heavily on consumers or producers, (ii) why government revenue raised from the tax is not a good indicator of the true cost of the tax, and (iii) how deadweight loss arises as a result of the tax. a. The government imposes an excise tax on the sale of all college textbooks. Before the tax was imposed, 1 million textbooks were sold every year at a price of \$50. After the tax is imposed, 600,000 books are sold yearly; students pay \(\$ 55\) per book, \(\$ 30\) of which publishers receive. b. The government imposes an excise tax on the sale of all airline tickets. Before the tax was imposed, 3 million airline tickets were sold every year at a price of \(\$ 500\). After the tax is imposed, 1.5 million tickets are sold yearly; travelers pay \(\$ 550\) per ticket, \(\$ 450\) of which the airlines receive. c. The government imposes an excise tax on the sale of all toothbrushes. Before the tax, 2 million toothbrushes were sold every year at a price of $\$ 1.50$. After the tax is imposed, 800,000 toothbrushes are sold every year; consumers pay \(\$ 2\) per toothbrush, \(\$ 1.25\) of which producers receive.

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?
See all solutions

What do you think about this solution?

We value your feedback to improve our textbook solutions.

Study anywhere. Anytime. Across all devices.

Sign-up for free