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Chapter 18: Problem 3

What is the difference between a marginal tax rate and an average tax rate? Which is more important in determining the effect of a change in taxes on economic behavior?

Short Answer

Expert verified
The main difference between the marginal tax rate and the average tax rate is that the marginal tax rate refers to the tax on the next dollar earned while the average tax rate is the total tax paid divided by total income. When determining the effect of a change in taxes on economic behavior, the marginal tax rate is more important as it influences decisions about earning additional income.

Step by step solution

01

Define Marginal Tax Rate

Marginal Tax Rate refers to the amount of tax paid on the next dollar earned. It often increases as the taxable amount increases, forming a concept known as 'progressive taxation'
02

Define Average Tax Rate

Average Tax Rate is the total tax paid divided by total income earned. It reflects the overall share of income that is paid in taxes.
03

Compare Marginal and Average Tax Rates

While the Average Tax Rate gives a general idea of the proportion of earnings that are paid in taxes, Marginal Tax Rate is significant in making decisions related to additional income or expense. It signifies how much of the next dollar earned will be taken as tax.
04

Determine the Importance in Economic Behavior

When it comes to influencing behavior or decision-making, Marginal Tax Rate plays a more impactful role. This is because it changes with each additional dollar earned, influencing people's willingness to earn more income (or conversely to find ways to avoid this extra tax)

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Most popular questions from this chapter

Governments often have multiple objectives in imposing a tax. In each part of this question, use a demand and supply graph to illustrate your answer. a. If the government wants to minimize the excess burden from excise taxes, should these taxes be imposedon goods that have price-elastic demand or on goods that have price-inelastic demand? b. Suppose that rather than minimizing excess burden, the government is most interested in maximizing the revenue it receives from the tax. In this situation, should the government impose excise taxes on goods that have price- elastic demand or on goods that have price-inelastic demand? c. Suppose that the government wants to discourage smoking and drinking alcohol. Will a tax be more effective in achieving this objective if the demand for these goods is price elastic or if the demand is price inelastic?

Suppose the government eliminates the federal income \(\operatorname{tax}\) and replaces it with a consumption tax. With a consumption tax, individuals pay a tax on only the part of their income they spend rather than save. Think about the effect of this change on the market for automobiles. Can you necessarily tell what will happen to the price and quantity of automobiles? Briefly explain.

What is a Lorenz curve? What is a Gini coefficient? If a country had a Gini coefficient of 0.48 in 1960 and 0.44 in 2018 , would income inequality in the country have increased or decreased?

Describe the main factors economists believe cause inequality of income.

Briefly discuss the effect of price elasticity of supply and demand on tax incidence.
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