Consumption Tax Questions
1. Suppose two workers earn labor incomes of $20,000 per year in each of three tax accounting periods. One worker saves 20% of her labor earnings in each of the first two periods and spends all of her savings and accumulated interest in the final period. The other worker never saves any of her labor earnings. The market rate of interest is 10%.
a. Calculate the discounted present value of taxes paid over the three periods for each worker under a 15% comprehensive income tax.
b. What would be the effect of substituting a comprehensive consumption tax for the income tax?
c. Comment on the equity and efficiency aspects of the two tax systems.
2. Your state has a retail sales tax of 10% but exempts food, prescription drugs, housing services (e.g. your cleaner), repair services (e.g. your plumber), and the consumption of water, electricity and other public utilities.
a. Use supply and demand analysis to explain how the prices of untaxed consumption items can be affected by the retail sales tax, even though they are not subject to taxation.
b. How can changes in the prices of nontaxed items affect the incidence of the retail sales tax?
Exam Review Questions
3. Use supply and demand analysis (e.g. graphs!) to consider the payroll tax in the U.S. this tax is legally shared equally between the employer and the employee, each paying 7.6% of wages. Using graphs (!), analyze the incidence and dead weight loss (excess burden/inefficiency) of this tax under each of the following conditions.
a. The labor supply is perfectly elastic and labor demand is relatively elastic.
b. Both labor supply and demand are highly elastic.
c. Labor supply is relatively inelastic; labor demand is relatively elastic.
d. Labor supply is relatively elastic; labor demand is relatively inelastic.
4. Which of the following taxes do you think would cause the larger deadweight loss? WHY? (It might be easiest to show with graphs).
a. A poll tax or a sales tax?
b. A sales tax on both services and goods or a sales tax on goods only?
c. An income tax only on interest and dividends or an income tax on income from all sources?
d. A tax on soda or a tax on all beverages?
5. Pick one change you would make to the current U.S. tax code – this could be involving the income tax, sales taxes, switching to a consumption tax, labor taxes, capital taxes, etc. Clearly specify the change.
a. What would be the equity implications of this change? Vertical equity? Horizontal equity?
b. What would be the efficiency implications of this change in terms of the size of dead weight loss generated?
c. How would this change affect the incidence of the tax? Explain.
d. Would this change be progressive? Regressive? Neutral? Explain.
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