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CRC Economics1

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2 Exercises Econ 304 Chapter 12

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CRC Economics3 Do you know … how to analyze a tax system? the different tax systems? why the current tax system is discouraging saving? what a marriage tax is?

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CRC Economics4 1a. How to analyze a tax system? Given the following tax table Answer the questions below.

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CRC Economics5 Questions to answer Suppose that Y = $75,000. How much are total taxes (T)? Total taxes (T) = Tax on income below $50,000 + Tax on income over $50,000 T = ($50,000*20%) + ($25,000*40%) = $20,000

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CRC Economics6 Questions to answer How much is the average tax rate (atr)? atr = T / Y atr = $20,000 / $75,000 = 27% i.e. on the average, the tax payment is 27 cents per dollar.

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CRC Economics7 Questions to answer How much is the marginal tax rate (mtr)? mtr = T / Y mtr = $10,000 / $25,000 = 40% i.e. the extra tax is 40 cents per extra dollar on income over $50,000.

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CRC Economics8 Questions to answer Does this tax system increase or reduce efficiency? The higher the mtr, the less efficient a tax system is. People have to pay more tax on extra income, they work less. mtr = 40% > atr = 27%. This tax system reduces efficiency.

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CRC Economics9 Questions to answer Does this tax system increase or reduce equity? The higher the mtr, the more tax is collected. The government has more money to help the poor. mtr = 40% > atr = 27%. This tax system increases equity.

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CRC Economics10 1b. How to analyze a tax system? Given the following tax table, where LS = lump sum Answer the questions below.

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CRC Economics11 Questions to answer Y $20,000 $40,000 T $4,000 atr 20% 10% mtr 0% Given two levels of income Y, fill in the blank boxes below.

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CRC Economics12 Questions to answer Y $20,000 $40,000 T $4,000 atr 20% 10% mtr 0% Does this tax system increase or reduce efficiency? This tax system increases efficiency. In fact, it is the most efficient system, because mtr = 0%

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CRC Economics13 Questions to answer Y $20,000 $40,000 T $4,000 atr 20% 10% mtr 0% Does this tax system increase or reduce equity? This tax system reduces equity. In fact, it is the least equitable system, because (1) the poor pay the same tax as the rich, and (2) the government will not have enough tax revenues to help the poor.

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CRC Economics14 2. Different tax systems Given the following tax table Answer the questions below.

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CRC Economics15 Questions to answer What are the atr’s under the proportional tax system? 25%, 25%, and 25%. What does that imply? Under the proportional tax system, the same tax rate applies to all income levels.

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CRC Economics16 Questions to answer What are the atr’s under the regressive tax system? 30%, 25%, and 20%. What does that imply? Under the regressive tax system, the tax rate falls as income rises.

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CRC Economics17 Questions to answer What are the atr’s under the progressive tax system? 20%, 25%, and 30%. What does that imply? Under the progressive tax system, the tax rate rises as income rises.

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CRC Economics18 Questions to answer Which system increases efficiency the most? The regressive system. Which system increases equity the most? The progressive system. What is the U.S. income tax system, proportional, regressive, or progressive?

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CRC Economics19 3. Why does the current U.S. income tax system discourage saving? Given the following tax table Answer the questions below.

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CRC Economics20 Questions to answer Suppose that there is no income tax on saving, what is the future value of $100 saving for 40 years (65-25) at 8% return per year? FV = PV(1+i) n = $100(1+8%) 40 = $2,172 How much is the effective rate of interest (i)? i = 8%

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CRC Economics21 Questions to answer Suppose that the tax rate on saving is 25%, what is the future value of $100 saving for 40 years (65-25) at 8% return per year? FV = PV(1+i) n = $100(1+8%(1-25%)) 40 = $1,029 How much is the effective rate of interest (i)? i = 6%

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CRC Economics22 Questions to answer What does that imply? The current U.S. tax system taxes the returns on saving, thus reducing the effective rate of interest and reducing people’s incentive to save.

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CRC Economics23 Questions to answer What if we remove that tax and replace it with a consumption tax? Then people will have more money at the end. They have the incentive to save more. This will be good for the economy in the long run. As more money is saved, more money will be invested. That means the U.S. economy will have more means to produce more goods and services. The economy will grow more.

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CRC Economics24 3. What is a marriage tax? Given the following tax table Answer the questions below.

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CRC Economics25 Questions to answer How much is the tax paid by Sam & Sally before marriage? After marriage? Before marriage T = $90,000 * 25% = $22,500. After marriage T = $22,500.

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CRC Economics26 Questions to answer How much is the tax paid by John & Joan before marriage? After marriage? Before marriage T = $80,000 * 25% = $20,000. After marriage T = $22,500.

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CRC Economics27 Questions to answer What happens? Sam, who does not work, and Sally pay the same amount of tax both before and after marriage. John and Joan, both working, by getting married, pay more tax. The tax law penalizes married couples, who both work, with a marriage tax. Was there any changes in the tax law about the issue? The tax law was changed to include some adjustments to the issue of marriage tax.

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CRC Economics28 Now you know … how to analyze a tax system. the different tax systems. why the current tax system is discouraging saving. what a marriage tax is.

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CRC Economics29

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