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CRC Economics 1
CRC Economics 2
ExercisesEcon 304
Chapter 12
CRC Economics 3
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?
CRC Economics 4
1a. How to analyze a tax system?
Given the following tax table
Answer the questions below.
$50,000 20%
$50,000 40%
Amount below
Amount over
Tax Rates
IncomeY
CRC Economics 5
Questions to answer
$50,000 20%
$50,000 40%
Amount below
Amount over
Tax Rates
IncomeY
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
CRC Economics 6
Questions to answer
$50,000 20%
$50,000 40%
Amount below
Amount over
Tax Rates
IncomeY
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.
CRC Economics 7
Questions to answer
$50,000 20%
$50,000 40%
Amount below
Amount over
Tax Rates
IncomeY
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.
CRC Economics 8
Questions to answer
$50,000 20%
$50,000 40%
Amount below
Amount over
Tax Rates
IncomeY
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.
CRC Economics 9
Questions to answer
$50,000 20%
$50,000 40%
Amount below
Amount over
Tax Rates
IncomeY
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.
CRC Economics 10
1b. How to analyze a tax system?
Given the following tax table, where LS = lump sum
Answer the questions below.
$4,000All levels
IncomeY
LS Taxes
CRC Economics 11
Questions to answer
$4,000All levels
IncomeY
LS Taxes
Y$20,000
$40,000
T$4,000
$4,000
atr20%
10%
mtr0%
0%
Given two levels of income Y, fill in the blank boxes below.
CRC Economics 12
Questions to answer
$4,000All levels
IncomeY
LS Taxes
Y$20,000
$40,000
T$4,000
$4,000
atr20%
10%
mtr0%
0%
Does this tax system increase or reduce efficiency?
This tax system increases efficiency. In fact, it is the mostefficient system, because mtr = 0%
CRC Economics 13
Questions to answer
$4,000All levels
IncomeY
LS Taxes
Y$20,000
$40,000
T$4,000
$4,000
atr20%
10%
mtr0%
0%Does this tax system increase or reduce equity?
This tax system reduces equity. In fact, it is the leastequitable 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.
CRC Economics 14
2. Different tax systems
Given the following tax table
Answer the questions below.
Tax atr (%) Tax atr (%) Tax atr (%)$12,500 25% $15,000 30% $10,000 20%
$25,000 25% $25,000 25% $25,000 25%
$50,000 25% $40,000 20% $60,000 30%
Income$50,000
$100,000
$200,000
Y Proportional Regressive Progressive
Tax System
CRC Economics 15
Questions to answer
Tax atr (%) Tax atr (%) Tax atr (%)$12,500 25% $15,000 30% $10,000 20%
$25,000 25% $25,000 25% $25,000 25%
$50,000 25% $40,000 20% $60,000 30%
Income$50,000
$100,000
$200,000
Y Proportional Regressive Progressive
Tax System
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 toall income levels.
CRC Economics 16
Questions to answer
Tax atr (%) Tax atr (%) Tax atr (%)$12,500 25% $15,000 30% $10,000 20%
$25,000 25% $25,000 25% $25,000 25%
$50,000 25% $40,000 20% $60,000 30%
Income$50,000
$100,000
$200,000
Y Proportional Regressive Progressive
Tax System
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 asincome rises.
CRC Economics 17
Questions to answer
Tax atr (%) Tax atr (%) Tax atr (%)$12,500 25% $15,000 30% $10,000 20%
$25,000 25% $25,000 25% $25,000 25%
$50,000 25% $40,000 20% $60,000 30%
Income$50,000
$100,000
$200,000
Y Proportional Regressive Progressive
Tax System
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 asincome rises.
CRC Economics 18
Questions to answer
Tax atr (%) Tax atr (%) Tax atr (%)$12,500 25% $15,000 30% $10,000 20%
$25,000 25% $25,000 25% $25,000 25%
$50,000 25% $40,000 20% $60,000 30%
Income$50,000
$100,000
$200,000
Y Proportional Regressive Progressive
Tax System
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, orprogressive?
CRC Economics 19
3. Why does the current U.S. income tax system discourage saving?
Given the following tax table
Answer the questions below.
Age Saving i(%)
25 $100 8% 0% 25%
65 $2,172 $1,029
8% 6%
Tax rate
Effective i(%)
CRC Economics 20
Questions to answer
Age Saving i(%)
25 $100 8% 0% 25%
65 $2,172 $1,029
8% 6%
Tax rate
Effective i(%)
Suppose that there is no income tax on saving, what is the futurevalue 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%
CRC Economics 21
Questions to answer
Age Saving i(%)
25 $100 8% 0% 25%
65 $2,172 $1,029
8% 6%
Tax rate
Effective i(%)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%
CRC Economics 22
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.
CRC Economics 23
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 meansto produce more goods and services.
The economy will grow more.
CRC Economics 24
3. What is a marriage tax? Given the following tax table
Answer the questions below.
Income t(%)
$10,000 0%
$10,000 25%
Sam Sally Total S&S Tax
$0 $100,000 $100,000 $100,000
$0 $22,500 $22,500 $22,500 $0
John Joan Total J&J Tax
$50,000 $50,000 $100,000 $100,000
$10,000 $10,000 $20,000 $22,500 $2,500Tax
MarriageBefore After
Income
Couple 1
Tax
Couple 2
Income
Less than
Above
CRC Economics 25
Questions to answer Income t(%)
$10,000 0%
$10,000 25%
Sam Sally Total S&S Tax
$0 $100,000 $100,000 $100,000
$0 $22,500 $22,500 $22,500 $0
John Joan Total J&J Tax
$50,000 $50,000 $100,000 $100,000
$10,000 $10,000 $20,000 $22,500 $2,500Tax
MarriageBefore After
Income
Couple 1
Tax
Couple 2
Income
Less than
Above
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.
CRC Economics 26
Questions to answer Income t(%)
$10,000 0%
$10,000 25%
Sam Sally Total S&S Tax
$0 $100,000 $100,000 $100,000
$0 $22,500 $22,500 $22,500 $0
John Joan Total J&J Tax
$50,000 $50,000 $100,000 $100,000
$10,000 $10,000 $20,000 $22,500 $2,500Tax
MarriageBefore After
Income
Couple 1
Tax
Couple 2
Income
Less than
Above
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.
CRC Economics 27
Questions to answer What happens?
Sam, who does not work, and Sally pay the sameamount 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 adjustmentsto the issue of marriage tax.
CRC Economics 28
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.
CRC Economics 29