Homework 5

Fall 08
1 All things equal, producers bear more of a tax when supply is __________. All things
equal, consumers bear more of a tax when demand is __________.
a.
unit elastic; unit elastic
b.
elastic; elastic
c.
inelastic; inelastic
d.
elastic; inelastic
e.
inelastic; elastic
2.

A tax levied on producers is fully shifted to consumers when:

a.
demand is perfectly elastic.
b.
demand is perfectly inelastic.
c.
supply is perfectly inelastic.
d.
both a and c are true.
e.
both b and c are true.

3.

Horizontal equity incorporates the notion that

a.
those earning higher incomes should pay more in taxes.
b.
those earning equal incomes should pay the same in taxes.
c.
taxes paid should be unassociated with income levels.
d.
there should be no excess burden created by a tax.

4.

Vertical equity incorporates the notion that

a.
those earning higher incomes should pay more in taxes.
b.
those earning equal incomes should pay the same in taxes.
c.
taxes paid should be unassociated with income levels.
d.
there should be no excess burden created by a tax.

5. Which of the following statements is true?

a. The degree of equity of an income tax system depends on marginal tax rates.
b. The degree of equity of an income tax system depends on average tax rates.
c. The degree of efficiency of an income tax system depends on marginal tax rates.
d. All of the above statements are true.
e. Both b and c are true.
Answer: E (Page 598)
6. Suppose that the government were to impose a $3 tax on high-speed
Internet connections. The law states that $2/connection is to be paid to the
government by the producer and the remaining $1 is to be paid by the
consumer. Which of the following statements regarding the tax is true?
a. It shifts the supply of high-speed Internet connections to the left.
b. It shifts the supply of high-speed Internet connections to the right.
c. It shifts the demand for high-speed Internet connections to the left.
d. Both a and c are true.
e. Both b and c are true.

Answer: D (Pages 548, 550)

7. In a labor market in which demand is inelastic and supply is elastic, who
bears a tax levied on the firms?
a. only the workers
b. only the firms
c. both the workers and the firms, although the workers bear more of the tax
d. both the workers and the firms, although the firms bear more of the tax
e. more information needed to answer the question
Answer: D (Page 556-557)
8. Tax expenditures are revenues that
A) are always recouped during tax season.
B) only apply to large corporations.
C) are needed to get full exemptions.
D) are forgone due to preferential tax treatment.
Ans: d
9. A tax credit
A) is not the same as a tax deduction.
B) is another phrase for a tax deduction.
C) is never calculated on federal tax returns.
D) only applies to the EITC.
Ans: a
10. A tax system in which the average tax rates fall as income rises is a
__________ tax system; the way in which the average tax rate changes as
income rises is a measure of ________ equity.
a. regressive; vertical
b. regressive; horizontal
c. progressive; vertical
d. progressive; horizontal
e. proportional; horizontal
Answer: A (Page 523)
11. There is a 20% tax on the first $15,000 of income, a 30% tax on income
above $15,000 until $30,000, and a 40% tax on all income above $30,000.
What is the marginal tax rate for someone making $35,000?
a. 14.29%
b. 20%
c. 30%
d. 31.7%
e. 40%
Answer: E (Page 521)

12. Assume that the nominal rate of interest is 10% and that the inflation rate is 10%. The tax rate
on interest from savings is 25%, and in the first period, Wes has $100 in savings. After taxes,
what will Wes's nominal savings be one year from now?
a. $10
b. $105
c. $107.50
d. $110
e. none of the above
Answer: C (Pages 642-643)
13. Which of the following is true regarding the Earned Income Tax Credit (EITC)?
a. Single mothers who marry are always penalized by the EITC program.
b. The EITC creates a marriage penalty because its formula is different for two-parent families
than for single-parent families.
c. Single mothers who marry sometimes receive an EITC "marriage bonus."
d. Both a and b are true.
e. Both b and c are true.
Answer: C (Page 626)
14. When government borrowing decreases private investment by raising the market interest rate,
this is known as
A) the Directors Law.
B) crowding out.
C) positive economics.
D) the Ramsey Rule.
E) random error.
Ans: b
15. Disadvantages of government decentralization are
A) intercommunity externalities.
B) forgone scale economies in the provision of public goods.
C) inefficient taxation.
D) the lack of ability to redistribute income.
E) all of the above.
Ans: e

16. A tax on consumption for those who are nonsavers

A) is equivalent to a tax on income.
B) causes income gains to increase dramatically.
C) would be preferred to a tax on wealth.
D) makes it difficult to tell what the result for the nonsavers would be.
Ans: a

17. A wealth tax can be justified because it

A) helps to correct certain (inevitable) problems that arise in the administration of an income tax
B) the higher an individuals wealth, the greater his or her ability to pay, other things- including
income being the same
C) reduces the concentration of wealth, which is desirable socially and politically
D) are payments for benefits that wealth holders receive from government
E) all of the above
Ans: e
18. When the federal government gives a grant to a state or local government without restrictions
on use, this is known as
A) revenue sharing.
B) block grants.
C) endowments.
D) tax shelter.
E) fiscal indifference.
Ans: a
19. A Tiebout model involves
A) completely mobile individuals.
B) governments generating no externalities.
C) perfect information.
D) all of the above.
E) a and c.
Ans: d
20. Disadvantages of government decentralization are
A) intercommunity externalities.
B) forgone scale economies in the provision of public goods.
C) inefficient taxation.
D) the lack of ability to redistribute income.
E) all of the above.
Ans: e

21.

If a tax is efficient, it will necessarily be equitable.

a.
True.
b.
False.
c.
Uncertain.

22. One advantage of a consumption tax is that there are fewer problems with inflation.
A) True.
B) False.
C) Uncertain.
Ans: a
23 Interest deductibility does not provide an incentive for debt finance.
A) True.
B) False.
C) Uncertain.
Ans: b

Part 2
1. Which would a taxpayer in the 36% tax bracket prefer: a $2,000 tax exemption or a $700 tax
credit? What if the taxpayer were in the 28% tax bracket?
Ans: For 36% taxpayer: exemption $2,000(0.36) = $720; tax credit = $700. Choose exemption.
For 28% taxpayer: exemption $2,000(0.28) = $560; tax credit = $700. Choose tax credit.

2. Your textbook (Ch. 24) highlights a debate that has been going on for some years. The issue is
whether there should be a corporation tax, given that corporations are nothing more than groups
of people. Should there be a corporation tax? Why or why not?
Ans: The debate will be answered by investigation whether a switch in taxing systems will
generate the same level of tax revenue without causing harm to the economy. Theoretical models
have yielded mixed results as to the effectiveness of a switch. It will have to be tested empirically
to know for sure.
-reduces tax avoidance

3 Jennifer lives in two periods. In the first period, her income is fixed at $20,000; in the second,
it is $28,000. She can borrow and save at the market interest rate of 8 percent.
(A) Sketch her intertemporal budget constraint.
(B) Suppose that Jennifer is unable to borrow at any rate of interest, although she can still save at
8 percent. Sketch her intertemporal budget constraint.
Ans:
(A)

(B)

4. Refer to Figure 16.1 in your textbook. Suppose that the total number of hours (T) is 720 and
the wage rate is $10. Suppose further that all income is spent on consumption, so that the vertical
axis is also total consumption.
(A) Sketch this graph.
(B) Sketch the graph if a 5% consumption tax is imposed.
(C) Can you say conclusively that a consumption tax will lower hours worked?
Ans:
(A) and (B)

(C) We cannot say, because of different preferences.

5, Illustrate the following circumstances using community indifference curves and the
local government budget constraint:
a. an unconditional grant increases both the quantity of public goods purchased and
local taxes.
b. a matching grant leaves provision of the public good unchanged
c. a closed-ended matching grant has the same impact as a conditional nonmatching
grant.
d. A close-ended matching grant leaves local taxes unchanged

22-3.

c.

6.
(12 pts.) The market demand for stuffed rabbits is Q = 2,600-20P, and the
government intends to place a $4 per bunny tax on stuffed rabbit purchases. Calculate
the excess burden (deadweight loss) of this tax when:
a. Supply of stuffed rabbits is Q= 400.
b. supply of stuffed rabbits is Q = 12P
c. explain why the dead weight loss calculations differ between a and b
d.

7. (20 pts.) Based on #8, Ch 15 in Rosen, p. 350 with the tax levied on consumers.
In an effort to reduce alcohol consumption, the government is considering a $1
tax on each gallon sold to be collected at retail (the tax is levied on consumer).
Suppose the supply curve for liquor is upward sloping and its equation is Q =
30,000P (where Q is the number of gallons of liquor and P is the price per gallon).
The demand curve for liquor is Q = 500,000 20,000P.
a.
b.
c.
a.

Sketch an illustration of the equilibrium and show the effect of the new $1
tax.
What is the tax revenue generated.
What share of the burden is borne by consumers and by producers?

Before-tax equilibrium: P = $10 and Q = 300,000

After-tax equilibrium: P = $10.60 and Q = 288,000
Consumers pay $10.60 and producers receive $9.60.
Excess Burden = (12,000)($0.60) + (12,000)($0.40) = $6,000.

P
tax revenue

S
$10.6
0
$10

excess burden

unit tax

$9.6
0
D0
D1
288,00
0

d.
e.
f.

300,00
0

On your graph, identify the excess burden of the $1 tax on consumers.

Using algebra, calculate the excess burden generated by the tax.
Compare the losses of both consumer and producer surplus to tax revenues