Chapter 10 The Government in the Economy

Active Learning Exercises for Chapter 10: The Government in the Economy 1. (Taxation and government spending at the state level) The textbook reports state and local receipts and spending by category. Select a state and go to the United States Census Bureau website and find the Annual Survey of State Government Finances Summary Table. For the state you selected compare the receipts and spending by category. Which categories represent a larger share of receipts or spending than the national average? Solution: At the time of publication this information was available at the following link: http://www.census.gov/govs/state/. 2. (Classifying tax systems) The Institute on Taxation and Economic Policy (ITEP) published a report (http://www.itepnet.org/whopays3.pdf) which shows that in the state of Florida, the families in the lowest 20 percent income group pay 13.5 percent of their income towards state taxes while families in the 60 to 80th percentile paid 7.6 percent of their income towards state taxes. And finally, the top 1 percent of families by income paid 2.6 percent of their income towards taxes. Would the Florida tax system be classified as progressive, proportional, or regressive? Select a state other than Florida and look at the report. Classify the state’s tax system. The report shows for each state the share of income paid by type of tax. Classify each type of tax for the state you examined. Solution: As those with higher incomes pay smaller shares of their income towards state taxes, the system would be classified as regressive. 3. (Income tax brackets; calculating tax rates) In 2013 Phil Mickelson, a professional golfer, made a comment regarding his negative view of recent tax increases in California. Below is the tax rate schedule for California in 2013. Problem 1 in the textbook gives the 2013 federal income tax rate for a single individual (assume for this problem that these rates apply to Mr. Mickelson). Phil Mickelson reportedly made approximately $49 million in 2013. 2013 California Income Tax Rates Taxable Income Rate $0 to $7,582 1.0% $7,582 to $17,976 2.0% $17,976 to $28,371 4.0% $28,371 to $39,384 6.0% $39,384 to $49,774 8.0% $49,774 to $254,250 9.3% $254,250 to $305,100 10.3% $305,100 to $508,500 11.3% $508,500 and above 12.3% A. Calculate the 2013 total federal income tax payable for Phil Mickelson. B. Calculate the 2013 total state income tax payable for Phil Mickelson. C. Combining the state and federal income tax rates, what was Phil Mickelson’s marginal income tax rate in 2013? D. Combining the state and federal income taxes, calculate Phil Mickelson’s average tax rate in 2013. Solution: A. $19,361,764 B. $6,013,884 C. 12.3% +39.6% = 51.9% D. (19,361,764 + 6,013,884)/49,000,000 = 51.8% ange 1 range 2 marginal income tax rate tax payment (Marginal income X Tax rate) 0 7582 7582 0.01 75.82 7582 17976 10394 0.02 207.88 17976 28371 10395 0.04 415.8 28371 39384 11013 0.06 660.78 39384 49774 10390 0.08 831.2 49774 254250 204476 0.093 19016.268 254250 305100 50850 0.103 5237.55 305100 508500 203400 0.113 22984.2 508500 49000000 48491500 0.123 5964454.5 Total state tax $6,013,884.00 range 1 range 2 marginal income tax rate tax payment 0 8925 8925 0.1 892.5 8925 36250 27325 0.15 4098.75 36250 87850 51600 0.25 12900 87850 183250 95400 0.28 26712 183250 398350 215100 0.33 70983 398350 400000 1650 0.35 577.5 400000 49000000 48600000 0.396 19245600 Total federal tax $19,361,764 4. (Tax incidence; Deadweight loss) Suppose the market for movies on DVD is perfectly competitive and the market price is $15 per DVD. Now assume the government decides to put a $3 tax on each DVD sold and as a result of this policy change, consumers must pay a total of $16 to buy a DVD. A. What share of the tax are consumers paying? B. What share of the tax are producers paying? C. On a graph clearly label the areas on the graph that represent consumer surplus, producer surplus, tax incidence on consumers, tax incidence on producers, and deadweight loss before and after the tax. Solution: A. The price to consumers has increased by $1. The consumers are paying $1 of the $3 tax or one-third of the tax. B. The producers were receiving $15; however, if consumers are now paying $16 and then $3 goes to the government then the producers are left with only $13. As a result the producers are paying $2 of the tax or two-thirds. C. See the graph below. Before Tax With Tax Consumer Surplus ABC A Producer Surplus DEF F Tax Incidence on Consumer - B Tax Incidence on Producer - D Deadweight Loss - CE 5. (Tax incidence; Deadweight loss from taxes) Suppose the state of Virginia is struggling with its budget. Assume that in order to raise revenue the state decides to put a tax on all airline boardings (each time a person gets on a commercial flight). The state makes two claims: Claim #1: “We will not harm consumers. The tax of $20 for each boarding of a plane in Virginia will be paid by the airlines.” Claim #2: “Last year, there were 1,000,000 airplane boardings in Virginia so we expect to raise $20 million dollars with this tax.” Assess each of these two claims using a graph, evaluate the two statements made by the state. Explain in two to three sentences why you think the statements are likely correct or incorrect. Solution: Claim #1 is false. As we learned in the chapter, the incidence of the tax is not influenced by whether the tax is officially imposed on consumers or producers. The consumers would pay a portion of this tax. Claim #2 is also false. In order to raise the full $20 million from the tax, the equilibrium quantity of boarding would need to stay exactly the same. While we have too little information in this question to estimate the change in boardings, we can be confident that there would be something less than the original quantity. 6. (Price ceilings; Consumer Surplus; Producer Surplus; Deadweight loss) Recently many politicians have raised concerns over increasing average price of textbooks. Suppose the U.S. government passed a law mandating that textbooks have a maximum legal price of $100. Show the impact of this proposal in a graph. Clearly label the equilibrium price and quantity after the price ceiling takes effect. Also label consumer surplus, producer surplus, and deadweight loss before and after the policy is in effect. Solution: See graph below. Before Price Ceiling After Price Ceiling Consumer Surplus AB AC Producer Surplus CDE E Deadweight Loss - BD