Income redistribution

Question 1

What is the implication of utilitarianism?

Answer 1

In order to maximize the sum of utility of individuals in society, the government should redistribute income

Question 2

Under which 3 assumptions do we conclude that it is best to equalize incomes

Answer 2

1. Individuals have identical utility functions
2. The utility is concave in income (your first euro is much more valuable than your 100,000th euro) -> slope of utlity becomes flatter
3. The total amount of income is fixed (in reality not true, as it is affected by redistribution)

Question 3

In what 3 ways can governments redistribute income?

Answer 3

1. Through direct regulation to affect market outcomes (minimum wage laws, education spending)
2. Determining after-tax income (social security contributions, taxes)
3. In-kind transfers affecting purchasing power (subsidizing education, housing, good etc. to make certain products affordable)

Question 4

What does the gini-coefficient measure?

Answer 4

Inequality - percentage of population lined up from 0-100% after how much they earn -> the longer the curve is away from the line, the more inequality there is

Question 5

In the NL, how is inequlity?

Answer 5

More inequality in gross market incomes over time, but inequality in aftertax income more constant

Inequality is reduced by social security transfers and directly by the tax system

Question 6

What is the taxable income?

Answer 6

Annual gross income - exemptions and deductions

Question 7

What is the tax liability?

Answer 7

The amount you have to pay in tax, according to the rate schedule

Question 8

What are tax credits?

Answer 8

Amount which is directly subtracted from the tax liability (the amount you have to pay in tax)

Question 9

Difference between deductions and credits

Answer 9

Deductions: saves you the amount of the deduction * the tax rate -> allows you to possible move to a lower tax bracket, as it is subtracted from the taxable income

Tax credit: saves you euro-for-euro as it is directly subtracted from the tax liability -> lowers tax liability but does not allow you to move to a lower brackets

Question 10

Definition of progressivity

Answer 10

The average tax rate increases with income

Question 11

How can a flat-rate tax system also be progressive?

Answer 11

If the tax system as a basic exemption or tax credit -> low-income individual do not pay as much in tax as people who earn much above the deduction/tax credit. It reduces tax liability in general, but has a much higher reduction for low-income individuals

Question 12

What is a negative income tax?

Answer 12

When the government pays money to the taxpayer in case of negative taxable income (if you make income lower than the reduction/tax credit)

Question 13

What is the leaky bucket of Okun?

Answer 13

If you tax to redistribute, leisure time will become a bit cheaper compared to working (than before), leading to individuals substituting working for a bit more leisure time -> income for the state from high income flows away as they decide to work less

Question 14

What is the income and substitution effect of a tax on working hours?

Answer 14

Income effect: You become poorer because you pay the tax -> you need to work more to consume

Substitution effect: leisure time becomes cheaper than working -> you substitute working for leisure time

Income and substitution effect work in opposite directions

Question 15

What is the income and substitution effect of a tax on labor supply decisions (deciding to work or not)?

Answer 15

Income effect: You have less income and need to work more to maintain your level of income -> labor supply increases

Substitution effect: the tax rate on the marginal euro earned makes spare time cheaper -> labor supply decreases

In practice, substitution effect is much larger than income effect

Question 16

What is the marginal tax burden?

Answer 16

The part of total labor costs that do not end up as disposable income for the employee -> the amount you have to pay to the government for every euro earned extra (the tax rate for the next/last euro earned)

Question 17

The marginal tax burden affects…

Answer 17

How strong the reduction in working hours will be when introducing a tax (intensive labor supply)

Question 18

What is the average tax burden?

Answer 18

Your overall tax rate; affecting the decision to work or not (extensive labor supply)

Question 19

Describe the earned income tax credit in the NL

Answer 19

For low-income individuals, the marginal tax burden is low -> the government is subsidizing them by reducing their tax liability

From 20,000 onwards, the tax income credit is more or less constant -> working has no consequence for your marginal tax burden

From 40,000 euros onwards, the tax credit is reduced, meaning that for every euro earned extra, you have to pay extra taxes to repay the amount of credit you received before

Question 20

An earned income tax credit changes the…

Answer 20

Marginal tax burden - reducing it for low-income individuals and increasing it for high-income individuals

Question 21

What is the trade-off of redistribution?

Answer 21

More redistribution (social benefit) affects work incentives (increasing welfare loss)

Question 22

How should a tax be organized regarding welfare loss?

Answer 22

So that possible disincentives to work are not larger than necessary

Question 23

From a theoretical perspective, who should have a low marginal and average tax burden?

Answer 23

Low marginal tax burden for the median income earner (very large group in society) to get them to work more

Low average tax burden on the working poor to get them to start working

Question 24

The earned income tax credit is essentially a type of…

Answer 24

Subsidy for an extra euro earned along the phase-in part

And an extra marginal burden per extra euro earned along the phase-out part

Question 25

How does the Earned Income Tax Credit affect households differently?

Answer 25

If two households earn the same amount of money in total, but one has one income earner and the other has two, the marginal tax burden will be much higher for the first household

Question 26

How does the marginal and average tax burden cause a welfare loss?

Answer 26

By reducing the hours worked or the labor participation decision

Question 27

What 3 things does an earned income tax credit do?

Answer 27

1. Give people money
2. Motivate people to start working
3. Motivating low-income people to work more