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Chapter 7: Problem 12

You are advising the government on how to pay for national defense. There are two proposals for a tax system to fund national defense. Under both proposals, the tax base is an individual's income. Under proposal A, all citizens pay exactly the same lump-sum tax, regardless of income. Under proposal B, individuals with higher incomes pay a greater proportion of their income in taxes. a. Is the tax in proposal A progressive, proportional, or regressive? What about the tax in proposal B? b. Is the tax in proposal A based on the ability-to-pay principle or on the benefits principle? What about the tax in proposal \(\mathrm{B}\) ? c. In terms of efficiency, which tax is better? Explain.

Short Answer

Expert verified
Answer: Proposal A is a regressive tax, based on the benefits principle, and is more efficient than proposal B. Proposal B is a progressive tax, based on the ability-to-pay principle, and is less efficient than proposal A.

Step by step solution

01

a. Tax Types: Proposal A and Proposal B

For proposal A, everyone pays the same lump-sum tax, regardless of their income. This means that lower-income individuals pay a higher proportion of their income in taxes compared to higher-income individuals. Therefore, the tax in proposal A is regressive. On the other hand, proposal B requires higher-income individuals to pay a higher proportion of their income in taxes. This indicates that the tax in proposal B is progressive.
02

b. Tax Principles: Proposal A and Proposal B

Proposal A is based on the benefits principle, as the tax is the same for everyone irrespective of their income. Every individual is assumed to receive the same level of benefits from the government's national defense spending, so they pay the same amount in taxes. In contrast, proposal B is based on the ability-to-pay principle. This principle suggests that people with higher incomes should pay higher taxes because they have a greater ability to pay. Therefore, the tax structure in proposal B reflects this principle by having higher-income individuals pay a greater proportion of their income in taxes.
03

c. Efficiency: Comparing Proposal A vs. Proposal B

In terms of efficiency, we need to consider the impact of the two tax proposals on economic behavior and the overall tax collection process. Proposal A, being a lump-sum tax, does not distort individuals' economic decisions as it does not change with income. Since everyone pays the same amount of tax regardless of income, there is no disincentive to work more or earn additional income. As a result, proposal A can be considered more efficient as it has fewer negative effects on individual incentives and productivity. However, in Proposal B, higher-income individuals face higher tax rates, potentially discouraging them from pursuing additional income. This can lead to a reduction in overall economic activity and may even encourage tax avoidance and evasion. In terms of efficiency, this makes proposal B less efficient than proposal A. In conclusion, while proposal A is regressive and based on the benefits principle, it is generally more efficient compared to the progressive and ability-to-pay based proposal B.

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Key Concepts

These are the key concepts you need to understand to accurately answer the question.

Regressive Tax
A regressive tax is one where low-income earners pay a higher percentage of their income compared to high-income earners. In simple terms, as your income decreases, the rate of tax you pay increases. This can seem counterintuitive to many people, but it is a scenario that occurs when everyone pays the same amount of tax, regardless of their income.
In the context of the exercise, Proposal A describes such a tax system. Here, each citizen pays a fixed lump-sum tax. While the absolute amount is the same for everyone, this lump sum represents a larger share of a low-income individual's total income than that of a high-income individual.
This type of tax is regressive because it places a disproportionate financial burden on lower-income individuals. While they pay the same amount as wealthier individuals, it eats up a larger portion of their available income, leaving them with less disposable income to cover other expenses.
Progressive Tax
Progressive tax systems are based on the principle of taxing individuals based on their ability to pay. In other words, as an individual's income increases, the percentage of income paid in taxes also rises. This ensures that those who earn more, contribute more to the public coffers in percentage terms.
In Proposal B of the exercise, the tax system is structured to be progressive as it levies higher tax rates on individuals with higher incomes. This way, more affluent individuals pay a larger proportion of their incomes, ensuring that their greater financial resources are reflected in their tax contributions.
The progressive tax is seen as fairer by many because it aligns with the concept that those who have the means to pay more should do so. It redistributes the tax burden more equitably among different income groups, which can help in addressing economic inequality.
Ability-to-Pay Principle
The ability-to-pay principle is the idea that taxes should be levied according to an individual's ability to shoulder the financial burden. This means those with higher income and wealth should contribute more, as they are better positioned to afford paying higher taxes without impairing their standard of living.
In the exercise, Proposal B leverages this principle. It dictates that individuals with higher incomes pay a larger share of their income in taxes. Thus, it ensures that higher earners contribute more in proportion to their financial capabilities.
This principle can help to ensure that public services are funded without placing undue strain on those who are less financially established. By following the ability-to-pay principle, governments can create a more balanced approach to taxation that takes into account the economic circumstances of all citizens.

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Most popular questions from this chapter

In the United States, each state government can impose its own excise tax on the sale of cigarettes. Suppose that in the state of North Texarkana, the state government imposes a tax of \(\$ 2.00\) per pack sold within the state. In contrast, the neighboring state of South Texarkana imposes no excise tax on cigarettes. Assume that in both states the pre-tax price of a pack of cigarettes is \(\$ 1.00 .\) Assume that the total cost to a resident of North Texarkana to smuggle a pack of cigarettes from South Texarkana is \(\$ 1.85\) per pack. (This includes the cost of time, gasoline, and so on.) Assume that the supply curve for cigarettes is neither perfectly elastic nor perfectly inelastic.a. Draw a diagram of the supply and demand curves for cigarettes in North Texarkana showing a situation in which it makes economic sense for a North Texarkanan to smuggle a pack of cigarettes from South Texarkana to North Texarkana. Explain your diagram. b. Draw a corresponding diagram showing a situation in which it does not make economic sense for a North Texarkanan to smuggle a pack of cigarettes from South Texarkana to North Texarkana. Explain your diagram. c. Suppose the demand for cigarettes in North Texarkana is perfectly inelastic. How high could the cost of smuggling a pack of cigarettes go until a North Texarkanan no longer found it profitable to smuggle? d. Still assume that demand for cigarettes in North Texarkana is perfectly inelastic and that all smokers in North Texarkana are smuggling their cigarettes at a cost of \(\$ 1.85\) per pack, so no tax is paid. Is there any inefficiency in this situation? If so, how much per pack? Suppose chip- embedded cigarette packaging makes it impossible to smuggle cigarettes across the state border. Is there any inefficiency in this situation? If so, how much per pack?

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?

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 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.

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.
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