LECTURE 6 Flashcards
3 uses of income tax by government
- Fund public services.
- redistribute income
- Provide insurance
3 sources of taxable income
- earned income
- non-earned income e.g. property income
- taxable benefits e.g. state pension
The UK PIT system is approx UNITARY. What does this mean?
Income is aggregated and tax is calculated on the aggregate.
basic, higher and additional rates in UK.
20%, 40% and 45%
The UK PIT system consists of 2 things…
- Tax: income and NICs
2. Tax credits - form of benefits.
Average tax rate formula
total tax paid / income = T(Y)/Y = tax paid per unit of income
Marginal tax rate formula
change in total tax paid / change in income = change in tax paid for 1 unit increase in income.
MTR under progressive system
MTR increases with income so higher income individuals pay a greater proportion of their income in tax.
MTR under regressive system
MTR decreases with income so higher income individuals pay a smaller proportion of their income in tax. Same tax amount e.g. sin taxes.
MTR under proportional system
MTR same for all levels of income so all individuals pay same proportion of their income in tax. Pay same tax rate = flat tax.
Extensive margin of labour supply
whether to be in LF or not.
Intensive marginal of labour supply
How many hours to work conditional on being in LF.
Consumer utility function and BC in consumption leisure optimisation problem
Max U(c, l) s.t. C = (1-t)wL + R
What’s the opportunity cost of leisure?
Wage
Effective wage =
(1 - t)w = post-tax wage.
What’s another constraint for consumer consumption leisure optimisation besides BC?
TIME constraint: L + l = T
How do consumption, leisure and labour affect utility?
U’(c) > 0
U’(l) > 0
U’(L) < 0 - utility decreases in labour
Labour-consumption trade off
U’(c) > 0, U’(L)<0 but need to work to earn money to consume.
What’s R in consumer c-l optimisation?
R = non-labour income. c = R if do not work still have some money.
Slope of BC in consumption-leisure space
slope = –(1-t)w = opportunity cost of leisure in terms of post-tax wage and so consumption lost.
What’s the SE if tax rate decreases?
Lower t = higher effective wage = higher opportunity cost of leisure. BC pivots so steeper. Substitute leisure for labour as leisure becomes relatively more expensive.
What’s the IE if tax rate decreases?
Tax rate decreases = higher disposable income. Assume consumption and leisure both normal goods = consume more of both.
SO: how does a decrease in t affect labour incentives through SE and IE?
SE: lower t = greater incentive to work
IE: lower t = more leisure since normal good = disincentive to work.
SO: how does an increase in t affect labour incentives through SE and IE?
SE: higher t = less incentive to work
IE: higher t = less leisure since normal good = incentive to work.