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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

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?

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.

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 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.

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?
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