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Public Finance questions and answers, Exercises of Public finance

Answers to public finance questions

Typology: Exercises

2017/2018

Uploaded on 02/24/2018

proteacher41
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Problem #1
1. To calculate Mary’s comprehensive income, multiply the market value of the condominium ($100,000) by 5%
which is the increase in value. Make sure to change 5% to decimal first (.05) before multiplying it by 100,000.
100,000(.05) = $5,000 this is the amount of increase to the value of the condo.
2. Then, multiply the market value of the condominium ($100,000) by 3% which is the inflation rate. Make sure to
change 3% to decimal first (.03) before multiplying it by 100,000.
100,000(.03) = $3,000 this is the amount of inflation
3. Subtract the amount of inflation from the amount of increase and then add that amount to Mary’s earnings to get
her comprehensive income.
5,000 – 3,000 + 50,000 = $52,000 this is Mary’s comprehensive income.
4. Now, if she were subjected to comprehensive income tax at 20% flat rate, her tax liability can be calculated by
multiplying her comprehensive income ($52,000) by 20%. Make sure to change 20% to decimal first (.20) before
multiplying it by 52,000.
52,000(.20) = $10,400 this is Mary’s tax liability for the year.
In summary, Mary has a real unrealized capital gain of $2,000. Her comprehensive income is therefore $52,000. Under a
20-percent, flat-rate tax, her tax liability would be $10,400 for the year.
Problem #2
1. To calculate the change in well-being that would result from a $10 billion increase in taxes (15%) on labor
income, we would multiply $10 billion by 15%. Make sure to change 15% to decimal first (.15) before
multiplying it by 10 billion.
10,000,000,000(.15) = $1,500,000,000 or $1.5 billion this is the added excess burden of labor income
2. To calculate the well-being that would result from a $10 billion reduction in taxes (45%) on capital income, we
would multiply $10 billion by 45%. Make sure to change 45% to decimal first (.45) before multiplying it by 10
billion.
10,000,000,000(.45) = $4,500,000,000 or $4.5 billion this is the reduction of excess burden of capital
income
3. To calculate the net increase in well-being, subtract the added excess burden of labor income (1.5 billion) from
the reduction of excess burden of capital income (4.5 billion).
4.5 billion – 1.5 billion = $3,000,000,000 or $3 billion this is the net increase in well-being.
In summary, a $10 billion reduction in taxes on capital income will reduce the excess burden by $4.5 billion. A $10 billion
increase in taxes in labor income will result in a new added excess burden of $1.5 billion. There will be a net increase in
well-being of $3 billion because of the change.
Problem #3
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Problem

  1. To calculate Mary’s comprehensive income, multiply the market value of the condominium ($100,000) by 5% which is the increase in value. Make sure to change 5% to decimal first (.05) before multiplying it by 100,000.

100,000(.05) = $5,000 this is the amount of increase to the value of the condo.

  1. Then, multiply the market value of the condominium ($100,000) by 3% which is the inflation rate. Make sure to change 3% to decimal first (.03) before multiplying it by 100,000.

100,000(.03) = $3,000 this is the amount of inflation

  1. Subtract the amount of inflation from the amount of increase and then add that amount to Mary’s earnings to get her comprehensive income.

5,000 – 3,000 + 50,000 = $52,000 this is Mary’s comprehensive income.

  1. Now, if she were subjected to comprehensive income tax at 20% flat rate, her tax liability can be calculated by multiplying her comprehensive income ($52,000) by 20%. Make sure to change 20% to decimal first (.20) before multiplying it by 52,000.

52,000(.20) = $10,400 this is Mary’s tax liability for the year.

In summary, Mary has a real unrealized capital gain of $2,000. Her comprehensive income is therefore $52,000. Under a 20-percent, flat-rate tax, her tax liability would be $10,400 for the year.

Problem

  1. To calculate the change in well-being that would result from a $10 billion increase in taxes (15%) on labor income, we would multiply $10 billion by 15%. Make sure to change 15% to decimal first (.15) before multiplying it by 10 billion.

10,000,000,000(.15) = $1,500,000,000 or $1.5 billion this is the added excess burden of labor income

  1. To calculate the well-being that would result from a $10 billion reduction in taxes (45%) on capital income, we would multiply $10 billion by 45%. Make sure to change 45% to decimal first (.45) before multiplying it by 10 billion.

10,000,000,000(.45) = $4,500,000,000 or $4.5 billion this is the reduction of excess burden of capital income

  1. To calculate the net increase in well-being, subtract the added excess burden of labor income (1.5 billion) from the reduction of excess burden of capital income (4.5 billion).

4.5 billion – 1.5 billion = $3,000,000,000 or $3 billion this is the net increase in well-being.

In summary, a $10 billion reduction in taxes on capital income will reduce the excess burden by $4.5 billion. A $10 billion increase in taxes in labor income will result in a new added excess burden of $1.5 billion. There will be a net increase in well-being of $3 billion because of the change.

Problem #

  1. Why doesn’t it imply that the excess burden of a tax on the labor income of prime-age males is necessarily zero?

The excess burden is not zero because a perfectly inelastic market labor supply means that the income effect is offset by an equal and opposite substitution effect. The existence of a substitution effect means that there is a positive excess burden.

  1. What does a perfectly inelastic market labor supply imply about the incidence of taxes on labor income?

A perfectly inelastic market labor supply implies that the incidence of the tax is borne entirely by the workers, market equilibrium wages do not rise in response to the tax, and none of the tax is shifted to the employers.

  1. Why is there reason to believe that the overall market labor supply is not perfectly elastic when groups other than prime-age males are considered?

Overall market labor supply includes responses of many demographic groups. Spouses and the elderly often have more elastic labor supply than prime-age males.

  1. What possible problems exist in empirical studies of the response to taxes on labor income that might make it difficult to estimate actual labor market responses?

Factors that might affect labor supply that are difficult to measure include early retirement, absenteeism, reduced intensity of work, unwillingness to invest in more training, and choice of occupation.