Chapter 7 Homework

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1) Using the graph below,

A) impose an excise tax of $30 per unit,

B) calculate and show tax incidence,

C) calculate and show tax revenue,

D) calculate and show deadweight loss.

E) calculate and show producer and consumer surplus

You should do this by 1) modeling the tax as an upward shift of the supply curve, 2) Determine the new transacted quantity (use a rough estimate on the horizontal axis), 3) determine supply price and demand price, 4) determine tax incidence by calculating how much higher demand price is and how much lower supply price is, 5) calculate tax revenue based on the tax wedge and the transacted quantity, and 6) calculate deadweight loss using the area of a triangle method.

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Chapter 7 Homework 1) Using the graph below, A) impose an excise tax of $30 per unit, B) calculate and show tax incidence, C) calculate and show tax revenue, D) calculate and show deadweight loss. E) calculate and show producer and consumer surplus You should do this by 1) modeling the tax as an upward shift of the supply curve, 2) Determine the new transacted quantity (use a rough estimate on the horizontal axis), 3) determine supply price and demand price, 4) determine tax incidence by calculating how much higher demand price is and how much lower supply price is, 5) calculate tax revenue based on the tax wedge and the transacted quantity, and 6) calculate deadweight loss using the area of a triangle method. 2) Using the tax bracket table (below) for single filers, calculate the federal income tax payment associated with a gross income of $75,000 per year and average tax rate. Chapter 7 Taxes 1 Taxes  An excise tax is placed on the sale of each unit of a good or service  Our example will be a $40 tax placed on the sale of hotel rooms, paid by the seller at time of sale.  Think of the tax as just an extra cost for suppliers 2 Taxes 3 Taxes 4 Taxes  The tax is represented by a decrease in supply  The new equilibrium is between D and S2  The tax drives a “wedge” between D and S1  On either end of the wedge is supply price and demand price  We calculate the tax incidence with  1) the original market clearing price  2) the supply price  3) the demand price  Tax incidence – how the tax burden is shared between producers 5 and consumers Taxes  If the tax was placed on buyers of hotel rooms at time of sale rather than sellers;  The tax is represented by a downward shift of the demand curve  New equilibrium is found where D2 and S intersect  The wedge is driven between D1 and S  Tax incidence is figured the same as before 6 Taxes 7 Taxes  In fact, it doesn’t matter who officially pays the tax – the equilibrium outcome is the same 8 Incidence & Elasticity  Price elasticity of both supply and demand are what determines tax incidence  The next example of the market for gasoline illustrates how consumers can pay most of the tax  Free market equilibrium at $2  Excise tax of $1 (creates a wedge $1 high)  Supply price $1.95  Demand price $2.95  When the price elasticity of demand is low and the price elasticity of supply is high, the burden of an excise tax falls mainly on consumers. 9 Incidence & Elasticity 10 Incidence & Elasticity  The next example of the market for parking illustrates how producers can pay most of the tax  Free market equilibrium at $6  Excise tax of $5 (creates a wedge $5 high)  Supply price $1.50  Demand price $6.50  When the price elasticity of demand is high and the price elasticity of supply is low, the burden of an excise tax falls mainly on producers. 11 Incidence & Elasticity 12 Incidence & Elasticity  When Ed > Es, tax is mostly paid by producers  When Ed < Es, tax is mostly paid by consumers  When Ed = Es, tax burden is shared equally  In sentence form;  When the price elasticity of demand is higher than the price elasticity of supply, an excise tax falls mainly on producers. When the price elasticity of supply is higher than the price elasticity of demand, an excise tax falls mainly on consumers. 13 Incidence & Elasticity  Application: Who pays the FICA tax?  Federal Insurance Contributions Act  Requires workers to contribute to Social Security (85%) Medicare (15%)  Employees pay 6.2% of earnings, employers pay 7.47%  For example someone earning $100 will pay $6.20 of it as FICA and their employer pays an additional $7.47.  Price elasticity of demand for labor is very elastic (Ed=3)  Price elasticity of supply for labor is very inelastic 14  Workers pay most of the tax Incidence & Elasticity  PRACTICE (see graph next slide)  (assume the tax causes Q=50)  1) show the tax wedge  2) what is the per unit tax?  3) how much of the tax is paid by consumers?  4) how much of the tax is paid by producers?  5) show deadweight loss on the diagram  6) show tax revenue on the diagram 15 Incidence & Elasticity 16 Costs & Benefits of Taxation  Cost –  Administrative costs  deadweight loss resulting from market distortion (quantity too low) and loss of allocative efficiency  Benefit – revenue for the government to operate and (hopefully) provide public goods in an allocative and productively efficient way 17 Costs of a Tax  The administrative costs of a tax are the resources used by government to collect the tax, and by taxpayers to pay it, over and above the amount of the tax, as well as to evade it.  Accounting services  Legal services for tax payers  Collection services  Legal services for government 18 Deadweight Loss 19 Deadweight Loss  Area:  B is deadweight loss that used to be consumer surplus  F is deadweight loss that used to be producer surplus  A is tax revenue that used to be consumer surplus  C is tax revenue that used to be producer surplus  Tax revenue will be used to provide government services  Deadweight loss isn’t good for anything, and is wasteful of society’s resources 20 Deadweight Loss 21 Deadweight Loss  Looking at four scenarios based on various elasticities we will find:  Deadweight loss is smaller when:  Demand is more inelastic  Supply is more inelastic  Deadweight loss is larger when:  Demand is more elastic  Supply is more elastic 22 Deadweight Loss 23 Deadweight Loss 24 Deadweight Loss 25 Deadweight Loss 26 Revenue from Tax  Graphically, the revenue collected by an excise tax is equal to the area of the rectangle whose height is the tax wedge between the supply and demand curves and whose width is the quantity transacted under the tax. 27 Revenue from Tax Revenue = $40 * 5,000 = $200,000 28 Revenue from Tax Revenue = $60 * 2,500 = $150,000 29 Revenue from Tax  A tax rate is the amount of tax people are required to pay per unit of whatever is being taxed.  An increase in the tax rate causes goods to bring more revenue per unit (price effect) which increases revenue and also be more expensive so that fewer units to be sold (quantity effect) which decreases revenue 30 Revenue from Tax  When supply and demand are both very price elastic (flat), increasing the tax rate will lead to a large quantity effect  When supply and demand are both very price inelastic (steep), increasing the tax rate will lead to a small quantity effect 31 Analysis 32 Tax Fairness  Two principles of tax fairness  Benefits principle – those who benefit from the public spending should bear the burden of the tax  Ability-to-pay principle – those who can better afford to bear the burden of a tax should pay more of the tax  Efficiency v. Equity Tradeoff 33 Types of Taxes  A lump-sum tax is the same for everyone, regardless of any actions people take. A regressive tax.  Example: you are forced to pay a $50 fee to work in Wilkes- Barre. If you earn $5,000 per year that is 1% of income. If you earn $50,000 per year that is 0.1% of income.  A regressive tax takes a smaller share of the income of high- income taxpayers than of low- income taxpayers. 34 Types of Taxes  A proportional tax is the same percentage of the tax base regardless of the taxpayer’s income or wealth.  Example: 10% tax on income. A person earning $10,000 pays 10% of their income. So does a person earning $200,000. 35 Types of Taxes  The marginal tax rate is the percentage of an increase in income that is taxed away.  A progressive tax takes a larger share of the income of high- income taxpayers than of low- income taxpayers.  Example: The tax rate on the first $10,000 is 10% and increases to 15% on all further income. 36 Types of Taxes  The tax base is the measure or value, such as income or property value, that determines how much tax an individual or firm pays.  The tax structure specifies how the tax depends on the tax base.  An income tax is a tax on an individual’s or family’s income.  A payroll tax is a tax on the earnings an employer pays to an employee.  A sales tax is a tax on the value of goods sold.  A profits tax is a tax on a firm’s profits.  A property tax is a tax on the value of property, such as the value of a home.  A wealth tax is a tax on an individual’s wealth. 37 Types of Taxes  Proportional rate where everyone pays 25%  Progressive where highest earners pay 75%, else 0% 38 Taxes in the USA 39 Taxes in the USA 40 Taxes in the USA 41 Taxes in the USA 42 http://www.bankrate.com/finance/taxes/tax-brackets.aspx Tax payment | % Calculation  If income is $20,000  First bracket $9,075 x 10% = $907.50  Next bracket ($20,000 - $9,075) x 15% = $1,638.75  $907.50 + $1,638.75 = $2,546.25 Total federal income tax payment  $2,546.25/$20,000 = 12.7% of gross (before tax) income  You try to calculate for income of $59,000 43 http://www.bankrate.com/finance/taxes/tax-brackets.aspx Tax payment | % Calculation  If income is $59,000  First bracket $9,075 x 10% = $907.50  Next bracket ($36,900 - $9,075) x 15% = $4,173.75  Next bracket ($59,000 - $ 36,900) x 25% = $5,525  $10,606.25 Total federal income tax payment  $10,606.25/$59,000 = 18% of gross (before tax) income 44 Tax Rates by State  FYI  PA state income tax is 3.07% regardless of income  NY state income tax is 4% to 8.82% dependent on income  CA state income tax is 1% to 13.3% dependent on income  DE state income tax is 2.2% to 6.6% dependent on income  FL state income tax does not exist  CA is highest top bracket http://taxfoundation.org/article/state-personal-income-tax-rates-and-brackets-2014-update 45
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Running Head: Chapter 7 Homework

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Chapter 7 Homework
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Chapter 7 Homework

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Question 1
A) Impose an excise tax of $30 per unit,

B) Calculate and show tax incidence,
The shaded area is the tax incidence.
The consumer burden = (45 – 20) × (2 – 0)
The consumer burden ...


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I was struggling with this subject, and this helped me a ton!

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