Optimal income taxation

Question 1

When do is the income tax rate changed?

Answer 1

In the Budget, 2 per year in UK
- Not always big changes more gradual

Question 2

What is Progressive taxation?

Answer 2

Rate of tax increases as the taxable base (gross annual income) increases

Question 3

Why did Margaret Thatcher cut top rate income tax from 83% to 60%?

Answer 3

Incentive to become a top earner as you can earn more

Question 4

Why is globalisation a problem with income taxes?

Answer 4

As we are globalised, taxes can’t be too high as an incentive for people to stay
- Brits going to UAE now 450% in 5 years

Question 5

What is the Laffer Curve?

Answer 5

Relationship between rate of tax and government tax revenues,
Shows there a particular tax rate where gov revenue is maximized

Question 6

Why does the Laffer curve dip after the max?

Answer 6

• People leave (globalization)
• Stop working or part time
• Tax avoidance

Question 7

Main conclusions from the Laffer Curve

Answer 7

• Increasing rate of income tax doesn’t always raise tax revenue
• Tax revenue is 0 when tax rate is 0% and 100%
• After mid, raising the rate will reduce tax revenue

Question 8

Is there support for the Laffer Curve

Answer 8

No
E.g Laffer assosicated Ronald Reagan administration which saw highest cut of personal tax (70% to 28%)
- Result = Reagan doubled budget deficit by 2x and gov debt by 3x
- Conclusion = lower tax rate and lower tax revenue
- Evaluation = Difficult to interpret results as could be other macro variations (unemployment) that affected this

Question 9

Formula from Gov revenue from income taxes

Answer 9

T = tB
- T = Total gov revenue from income taxes
- t = rate of income tax (1 rate for all)
- B = Gross aggregate earnings

Question 10

Formula for B, for gov revenue from income taxes

Answer 10

Gross aggregate earnings
B is not constant, changes with tax policy
B = hwN
h - hours worked individually
w - hourly gross wage rate (same)
N = no. of workers employed

Question 11

Formula for Labour supply

Answer 11

h
h = f(t, X)
X - set of other things that determine h (e.g age, health, gross wage)

Question 12

Theory of labour supply

Answer 12

Consumers can choose how much to work (h) and how much to consume (c)
- Max U = (c, H-h)

U = Utility
H = total amout of time available, (e.g 24 hours)