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Answers to public finance questions
Typology: Exercises
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100,000(.05) = $5,000 this is the amount of increase to the value of the condo.
100,000(.03) = $3,000 this is the amount of inflation
5,000 – 3,000 + 50,000 = $52,000 this is Mary’s comprehensive income.
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.
10,000,000,000(.15) = $1,500,000,000 or $1.5 billion this is the added excess burden of labor income
10,000,000,000(.45) = $4,500,000,000 or $4.5 billion this is the reduction of excess burden of capital income
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 #
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.
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.
Overall market labor supply includes responses of many demographic groups. Spouses and the elderly often have more elastic labor supply than prime-age males.
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.