Midterm Topic 9

Question 1

fiscal policy

Answer 1

government’s policies on taxation and spending

Question 2

lump sum taxes

Answer 2

do not depend on economic activities and therefore do not affect economic behavior (individual’s economic decisions, activities, incentives, etc). NON DISTORTIONARY

ex: per-head taxes, height, beauty.

Question 3

incentive taxes

Answer 3

depend on economic activities and can affect economic behavior, change in economic incentives. DISTORTIONARY

ex: sales taxes, income taxes, property taxes, profit taxes.

Question 4

myopic expectations

Answer 4

individuals observe current policies but do not form expectations about future implications and future government policies. “short-sighted”

Question 5

rational expectations

Answer 5

individuals/households observe current policies and update expectations about the implications on future outcomes and anticipate future government policies. “forward looking and perfectly rational”

Question 6

a reduction in lump sum taxes will negatively impact future generations

Answer 6

1. if tax cut causes a govt. deficit, then there is a higher future tax burden.
2. reduction in investment will reduce future capital and therefore future GDP

Question 7

twin deficit

Answer 7

deficit in both the government budget and the current account balance.

1. decreased tax revenues increase government deficit
2. decreased national saving increases domestic borrowing and increases the current account deficit.

Question 8

Ricardian equivalence

Answer 8

if households have rational expectations, they keep the same saving and consumption, adjusting for the current or anticipated future income shock (i.e. a current positive income shock from tax cuts means a future negative income shock from future tax raises or future cuts in benefits–>saves up for future negative shock)

Question 9

statutory incidence of a tax

Answer 9

indicates who is legally responsible for the tax payment

Question 10

economic incidence of a tax

Answer 10

indicates the changes in real income induced by the tax.

the economic incidence of a labor income tax is independent of whether it is levied on employees or employers (statutory incidence). it rather depends on the elasticities of labor demand and labor supply.

Question 11

tax burden according to elasticity

Answer 11

more elastic labor demand means greater burden for households.

more elastic labor supply means greater burden for firms

Question 12

Laffer curve

Answer 12

a reduction in tax rates, given high elasticities, can increase the tax base (amount of activity) relatively more than the reduction in the tax rate and therefore can increase tax revenues.

tax revenues are maximized by balancing the negative tax rate effect with the positive quantity effect.

Question 13

Pigouvian taxes

Answer 13

can correct negative externalities by setting higher tax rates that reduce the undesired activity and raise desired tax revenues

Question 14

a reduction in the tax rate would cause an increase in the tax rate only if…

Answer 14

1. the initial tax rate is sufficiently high

2. the economy is very responsive to changes in the tax rate