Practice Questions for Final - The share of capital gains included in taxable income decreased
Question # 00258737
Posted By:
Updated on: 04/21/2016 01:02 PM Due on: 05/21/2016
Practice Questions for Final
1. The share of capital gains included in taxable income decreased from three quarters
in 1990 to one half by 2001. Discuss each of the following statements, and defend
your answers:
a. The decreased taxation of capital gains will cause individuals to switch toward
riskier investments.
b. The tax system is now less efficient because the tax treatment of capital gains is
further from the Haig-Simons income concept.
c. The new law will improve individuals‘ welfare because they can change their
portfolios at lower costs.
d. Because the overall tax on the return to saving is now lower, personal savings
will increase.
2. In an economy, the labour supply curve is S = 5wa , where wa is the after-tax wage
rate. Assume that the before-tax wage rate is fixed at 10.
a. Derive an expression for tax revenues as a function of the tax rate.
b. If the current tax rate is 70%, is the government on the “good” side of the Laffer
curve? (Use a graph in your answer, and explain what it means to be on the
good side of the Laffer curve)
c. What is the elasticity of labour supply at the current tax rate?
d. What advice would you give the government if it is looking at possible tax reforms?
Bonus: What is the revenue maximizing tax rate?
3. The GST replaced the FST (MST) in 1991. This was seen as an economically astute
decision by the Federal Government.
a. Give 3 reasons why the GST is an improvement over the FST, drawing on the
formula for excess burden.
b. What is the difference between a zero-rated and a tax-exempt good? Explain
with an example.
c. Is a proportional consumption tax necessarily the most efficient? Why might a
proportional consumption tax be desirable regardless?
4. Many people argue that a consumption tax is preferable to an income tax, because
while income taxes distort both labour and capital markets, consumption taxes only
distort labour markets.
a. Explain why income taxes distort labour and capital markets
b. Explain why consumption taxes only distort labour markets
c. Does the fact consumption taxes distort only one market, while income taxes
distort two, make consumption taxes preferable? Explain.
1
5. There are several views on the incidence of property taxes.
a. Under the traditional view, who pays the tax on land? On structures? Explain
b. Under the “new view,” who pays the tax? Explain, and outline the output and
substitution effects.
c. When might it not make sense to think of property taxes as a “tax”? Explain
d. Briefly outline how all three views might be relevant.
6. Explain how the corporate tax system could be designed to maximize world and
national incomes, respectively.
7. Suppose James and John own a share in a corporation facing a corporate tax rate of
50%. James and John each face marginal tax rates of 20% and 50% respectively. For
every $2 in earnings by the corporation:
a. How much is paid out to James and John, each?
b. What is the effective tax rate on James and John if the corporate and personal
income tax systems are not integrated (no dividend tax credits)? Show your
work.
c. What is the effective tax rate on James and John if the corporate and personal income tax systems are partially integrated (dividend tax credits at the individual’s
marginal tax rate)? Show your work.
d. What is the effective tax rate on James and John if the corporate and personal
income tax systems are fully integrated (dividend tax credits at the corporate tax
rate)? Show your work.
e. Who benefits more from full integration?
8. Suppose there is a increase in payroll taxes, which does not lead to a decrease in
hours worked. A friend says that the tax “generates no excess burden because it does
not lead to changes in behaviour.” Is this statement true or false? Explain using a
simple labour-leisure choice model, and do not forget to make the distinction between
substitution and income effects.
9. Another friend, who happens to be a history major, sees the formula for excess burden
under a linear compensated demand curve and remarks: “In the formula for excess
burden, the tax rate is less than one. When it is squared, the result is smaller, not
bigger. Thus, having t2 instead of t in the formula makes the size of the tax less
important.”
a. Comment on this insight by your friend.
b. What does having t2 instead of t in the formula imply for the size of the tax base,
compared to the tax rate, all else the same? equal?
10. In Thailand, researchers have found that the price elasticities for food, alcohol, and
telecommunications are -.10, -.84, and -.025, respectively.
2
a. If the goal is to raise tax revenues with the least excess burden possible, what
should should be the tax rate on alcohol and telecommunications, when the tax
rate on food is fixed at 1% (assuming that the goods are unrelated in consumption)? Explain your answer.
b. Now if the government wants to combat alcohol addiction, how would your
answer to (a) change?
11. The tax system is filled with a variety of deductions and credits:
a. What is the difference between a deduction and a tax credit?
b. How do the benefits of deductions, and credits, change with the marginal tax
rate?
c. Compare the impact of deductions and credits on the progressivity of the tax
system.
12. A TV pundit claims that a proportional income tax does not satisfy horizontal equity,
because it places different burdens on individuals with the same lifetime income:
a. Construct a simple 2-period, 2-person example, showing how a proportional income tax places different burdens on individuals with the same lifetime income.
b. Why does the violation of horizontal equity arise?
c. Do consumption taxes face the criticism of the TV pundit? Explain
d. In what other dimension might consumption taxes be considered “unfair”?
13. The Canadian tax system allows corporation to deduct depreciated assets from revenues. For a $1000 investment in an asset with a tax life of 10 years, depreciated
using the straight-line method:
a. Derive a simple formula for the value of the capital cost allowance (CCA)?
b. Show why corporations would prefer a shorter tax life.
c. How does the value of the CCA change with the corporate tax rate?
14. An enduring debate among public finance economists concerns the desirability of
individual or family-based taxation. Assuming that we want a tax system that is progressive, marriage-neutral, and satisfies horizontal equity. Using a simple example,
explain:
a. How does individual based taxation perfom with the three criteria above? Explain
b. How does family based taxation perform? Explain
c. Given the above results, which unit of taxation would you prefer?
d. How does the spousal tax credit overcome some of the problems with individual
based taxation above?
3
Bonus: Taxes are generally considered to be inefficient and generate excess burdens.
Using a simple framework, and with reference to a social welfare function and utility possibilities curve, explain why the inefficiency of taxes might be desirable for a
society. Also, describe a situation in which a tax would increase efficiency.
4
1. The share of capital gains included in taxable income decreased from three quarters
in 1990 to one half by 2001. Discuss each of the following statements, and defend
your answers:
a. The decreased taxation of capital gains will cause individuals to switch toward
riskier investments.
b. The tax system is now less efficient because the tax treatment of capital gains is
further from the Haig-Simons income concept.
c. The new law will improve individuals‘ welfare because they can change their
portfolios at lower costs.
d. Because the overall tax on the return to saving is now lower, personal savings
will increase.
2. In an economy, the labour supply curve is S = 5wa , where wa is the after-tax wage
rate. Assume that the before-tax wage rate is fixed at 10.
a. Derive an expression for tax revenues as a function of the tax rate.
b. If the current tax rate is 70%, is the government on the “good” side of the Laffer
curve? (Use a graph in your answer, and explain what it means to be on the
good side of the Laffer curve)
c. What is the elasticity of labour supply at the current tax rate?
d. What advice would you give the government if it is looking at possible tax reforms?
Bonus: What is the revenue maximizing tax rate?
3. The GST replaced the FST (MST) in 1991. This was seen as an economically astute
decision by the Federal Government.
a. Give 3 reasons why the GST is an improvement over the FST, drawing on the
formula for excess burden.
b. What is the difference between a zero-rated and a tax-exempt good? Explain
with an example.
c. Is a proportional consumption tax necessarily the most efficient? Why might a
proportional consumption tax be desirable regardless?
4. Many people argue that a consumption tax is preferable to an income tax, because
while income taxes distort both labour and capital markets, consumption taxes only
distort labour markets.
a. Explain why income taxes distort labour and capital markets
b. Explain why consumption taxes only distort labour markets
c. Does the fact consumption taxes distort only one market, while income taxes
distort two, make consumption taxes preferable? Explain.
1
5. There are several views on the incidence of property taxes.
a. Under the traditional view, who pays the tax on land? On structures? Explain
b. Under the “new view,” who pays the tax? Explain, and outline the output and
substitution effects.
c. When might it not make sense to think of property taxes as a “tax”? Explain
d. Briefly outline how all three views might be relevant.
6. Explain how the corporate tax system could be designed to maximize world and
national incomes, respectively.
7. Suppose James and John own a share in a corporation facing a corporate tax rate of
50%. James and John each face marginal tax rates of 20% and 50% respectively. For
every $2 in earnings by the corporation:
a. How much is paid out to James and John, each?
b. What is the effective tax rate on James and John if the corporate and personal
income tax systems are not integrated (no dividend tax credits)? Show your
work.
c. What is the effective tax rate on James and John if the corporate and personal income tax systems are partially integrated (dividend tax credits at the individual’s
marginal tax rate)? Show your work.
d. What is the effective tax rate on James and John if the corporate and personal
income tax systems are fully integrated (dividend tax credits at the corporate tax
rate)? Show your work.
e. Who benefits more from full integration?
8. Suppose there is a increase in payroll taxes, which does not lead to a decrease in
hours worked. A friend says that the tax “generates no excess burden because it does
not lead to changes in behaviour.” Is this statement true or false? Explain using a
simple labour-leisure choice model, and do not forget to make the distinction between
substitution and income effects.
9. Another friend, who happens to be a history major, sees the formula for excess burden
under a linear compensated demand curve and remarks: “In the formula for excess
burden, the tax rate is less than one. When it is squared, the result is smaller, not
bigger. Thus, having t2 instead of t in the formula makes the size of the tax less
important.”
a. Comment on this insight by your friend.
b. What does having t2 instead of t in the formula imply for the size of the tax base,
compared to the tax rate, all else the same? equal?
10. In Thailand, researchers have found that the price elasticities for food, alcohol, and
telecommunications are -.10, -.84, and -.025, respectively.
2
a. If the goal is to raise tax revenues with the least excess burden possible, what
should should be the tax rate on alcohol and telecommunications, when the tax
rate on food is fixed at 1% (assuming that the goods are unrelated in consumption)? Explain your answer.
b. Now if the government wants to combat alcohol addiction, how would your
answer to (a) change?
11. The tax system is filled with a variety of deductions and credits:
a. What is the difference between a deduction and a tax credit?
b. How do the benefits of deductions, and credits, change with the marginal tax
rate?
c. Compare the impact of deductions and credits on the progressivity of the tax
system.
12. A TV pundit claims that a proportional income tax does not satisfy horizontal equity,
because it places different burdens on individuals with the same lifetime income:
a. Construct a simple 2-period, 2-person example, showing how a proportional income tax places different burdens on individuals with the same lifetime income.
b. Why does the violation of horizontal equity arise?
c. Do consumption taxes face the criticism of the TV pundit? Explain
d. In what other dimension might consumption taxes be considered “unfair”?
13. The Canadian tax system allows corporation to deduct depreciated assets from revenues. For a $1000 investment in an asset with a tax life of 10 years, depreciated
using the straight-line method:
a. Derive a simple formula for the value of the capital cost allowance (CCA)?
b. Show why corporations would prefer a shorter tax life.
c. How does the value of the CCA change with the corporate tax rate?
14. An enduring debate among public finance economists concerns the desirability of
individual or family-based taxation. Assuming that we want a tax system that is progressive, marriage-neutral, and satisfies horizontal equity. Using a simple example,
explain:
a. How does individual based taxation perfom with the three criteria above? Explain
b. How does family based taxation perform? Explain
c. Given the above results, which unit of taxation would you prefer?
d. How does the spousal tax credit overcome some of the problems with individual
based taxation above?
3
Bonus: Taxes are generally considered to be inefficient and generate excess burdens.
Using a simple framework, and with reference to a social welfare function and utility possibilities curve, explain why the inefficiency of taxes might be desirable for a
society. Also, describe a situation in which a tax would increase efficiency.
4
-
Rating:
/5
Solution: Practice Questions for Final