Chapter 7: Taxes

Question 1

KEY TERM:
Excise/sales tax

Answer 1

a tax on sales of a good or service or its value.

Question 2

KEY TERM:
Incidence

Answer 2

(of a tax) a measure of who really pays a tax.

Question 3

KEY TERM:
Tax Rate

Answer 3

the amount of tax that people are required to pay per unit of whatever is being taxed.

Question 4

KEY TERM:
Administrative Costs

Answer 4

(of a tax) the resources used for its collection, for the method of payment, and for any attempts to evade the tax.

Question 5

KEY TERM:
Benefits Principle

Answer 5

the principle of tax fairness by which those who benefit from public spending should bear the burden of the tax that pays for that spending.

Question 6

KEY TERM:
Ability-to-pay Principle

Answer 6

the principle of tax fairness by which those with greater ability to pay a tax should pay more tax.

Question 7

KEY TERM:
Lump-sum Tax

Answer 7

a tax that is the same for everyone, regardless of any actions people take.

Question 8

KEY TERM:
Trade-off between equity and efficiency

Answer 8

a tax system can be made fairer by moving it in the direction of the benefits principle or the ability-to-pay principle. But this will come at a cost because the tax system will now tax people more heavily based on their actions, increasing the amount of deadweight loss.

Question 9

KEY TERM:
Tax base

Answer 9

the measure or value, such as income or property value, that determines how much tax an individual or firm pays.

Question 10

KEY TERM:
Tax structure

Answer 10

specifies how a tax depends on the tax base; usually expressed in percentage terms.

Question 11

KEY TERM:
Profits tax

Answer 11

a tax on a firm’s profits.

Question 12

KEY TERM:
Income tax

Answer 12

tax on an individual’s or family’s income from wages or investment.

Question 13

KEY TERM:
Payroll tax

Answer 13

a tax on the earnings an employer pays to an employee.

Question 14

KEY TERM:
Property tax

Answer 14

a tax on the value of property, such as the value of a home.

Question 15

KEY TERM:
Wealth tax

Answer 15

a tax on an individual’s wealth.

Question 16

KEY TERM:
Proportional/flat tax

Answer 16

a tax that is the same percentage of the tax base regardless of the taxpayer’s income or wealth.

Question 17

KEY TERM:
Progressive tax

Answer 17

a tax that takes a larger share of the income of high-income taxpayers than of low-income taxpayers.

Question 18

KEY TERM:
Regressive tax

Answer 18

a tax that takes a smaller share of the income of high-income taxpayers than of low-income taxpayers.

Question 19

KEY TERM:
Marginal tax rate

Answer 19

the percentage of an increase in income that is taxed away.

Question 20

Why are taxes difficult to construct?

Answer 20

Taxes have a cost that is greater than an amount paid to the government - taxes distort incentives to engage in mutually beneficial transactions.

Question 21

3 thing policymakers look at when taxing:

Answer 21

Efficiency: maximise revenue + minimise costs (economic and admin costs - the idea that taxes should be designed to distort incentives as little as possible).
Fairness: ability to pay + benefit on individuals.
Nudge behavioural actions.

Question 22

What happens when a tax is applied?

Answer 22

Shift of one curve, movement on another.
An excise tax drives a wedge, equal to the size of the tax, between the price paid by consumers and the price received by producers. This wedge drives the price paid by consumers up and the price received by producers down. This tax leads to inefficiency by distorting incentives and creating missed opportunities for mutually beneficial transactions.
It does not matter who the tax is levied on, the outcome is the same.

Question 23

Elasticity and incidence?

Answer 23

The incidence of an excise tax depends on the price elasticity of supply and the price elasticity of demand.
When PED is inelastic and PES is elastic, burden is borne more by consumers as price paid by consumers rises more than price the decline in price of suppliers.
When PES is inelastic and PED is elastic, burden is borne more by producers as price decline is greater than price the rise in price paid by consumers.

Question 24

Benefits of taxation (revenue)?

Answer 24

Revenue for government from tax = tax wedge*quantity transacted under tax. But balance between greater tax rate and decrease in quantity transacted.

If PES and PED are low (inelastic), raising taxes almost certainly results in raising tax revenue. If PES and PED are high (elastic), raising taxes when tax rates are low may raise revenue and raising taxes when tax rates are high usually results in a loss of revenue. Policymakers take this into consideration when dealing with taxes that serve purpose to raise revenue (some do not such as sin taxes that discourage undesirable behaviour).

Question 25

3 costs of taxation:

Answer 25

DWL (greater elasticity = greater DWL)
Consumer and producer surplus lost to government revenue (not included in total surplus lost).
Administrative costs (depends on the technology of tax collection).

Question 26

Two principles of tax fairness:

Answer 26

Benefits (makes sense from an economic perspective to tax on those that benefit from public spending - but cumbersome to create a tax for each benefit).
Ability-to-pay

Question 27

2 main reasons for a mixture of progressive and regressive taxes:

Answer 27

1) Difference between levels of government (federal and state - states are subject to tax competition)
2) Difference between types of taxes (sales tax are more efficient, progressive income taxes are more equitable)

Question 28

Is the policymakers goal efficiency or equity?

Answer 28

Efficiency means taxing the products with low elasticity.
Equity means taxing according to benefits or ability-to-pay principle.

Question 29

How to calculate marginal tax rate?

Answer 29

Tax payable in the new bracket / income of the new bracket

Question 30

Problem with rogressive tax in regards to efficiency?

Answer 30

It creates an incentive problem - people are less likely to invest time and effort to raise earnings.

Question 31

Incidence calculation?

Answer 31

Cost of tax (price wedge) borne*quantity transacted.