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Chapter 18: Problem 6

(Related to the Chapter Opener on page 600 ) In 2017 , the Trump administration proposed changes to the federal tax code, including reducing the top corporate income tax rate from 35 percent to 15 percent. An article in the Wall Street Journal noted, "A tax overhaul could give companies more incentive to invest." a. What type of investments is the article referring to? Why would cutting the corporate income tax rate lead companies to engage in more investment? b. Some policymakers and economists are critical of cuts in the corporate income tax rate because they argue that such cuts increase income inequality. Does the incidence of the corporate income tax matter in evaluating this argument? Briefly explain.

Short Answer

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The article refers to capital investments - new equipment, buildings, machinery, research and development or other productive assets. Reduced corporate income tax rates lead to more investment by increasing the post-tax return on investments, thereby making more projects economically viable. Whether cuts in the corporate income tax rate increase income inequality depends on the incidence of the tax. If the burden of the tax falls predominantly on wealthier shareholders, a tax cut could increase income inequality, as these individuals retain a larger share of the profits.

Step by step solution

01

Understanding Investments and Tax Influence

The major types of investments companies typically participate in are capital investments. These typically include new equipment, buildings, machinery, research and development or other operating inputs necessary to increase productivity. When the corporate income tax rate is reduced, companies retain more of their earnings. They can utilize these additional funds in a way that brings about a higher return than the cost of capital, such as stimulating growth through capital investments.
02

Discuss Tax Incidence and Income Inequality

The incidence of a tax refers to who ultimately bears the burden of the tax. While companies are directly responsible to pay the corporate income tax, the incidence of the tax can fall on various stakeholders such as the company, its employees, its customers, or even its shareholders. If the tax incidence falls predominantly on the shareholders (who are typically wealthier individuals), a reduction in such tax rates might allow these individuals to retain a larger share of profits, thereby potentially exacerbating income inequality.

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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?

Which type of tax raises the most revenue for the federal government? What is the largest source of revenue for state and local governments?

What is the difference between a progressive tax and a regressive tax? Give an example of each.

(Related to Solved Problem 18.4 on page 621 ) Evaluate the following statement: "Policies to redistribute income are desperately needed in the United States. Without such policies, the roughly 13 percent of the population that is currently poor has no hope of ever climbing above the poverty line."

According to an article in the New York Times, when the French government imposed a new tax on sales of beer, t estimated that the retail price of beer would rise by he equivalent of 6 cents per half pint. A spokesman for he beer industry argued that the actual increase in price would be 25 cents per half pint. Discuss the differences between the French government's and the beer industry's estimates of the price elasticity of demand for beer.
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