Questions and answers

Question 1: The Laffer Curve [20 Points]

GROWTH ---------------------- -------------------------------------------REDISTRIBUTION

i) Define Points T* and R*?

ii) On the graph above, label the “Normal Zone” and the “Prohibitive Zone”

a) Define T* and R*

iii) Assume the tax rate is set to the right of R*.

a) What must the government do to raise government tax revenue?

b) What must the government do to increase economic growth?

c) What happens to economic growth and tax revenue if the government raises taxes?

iv) Draw two tax rates on the graph above showing how two tax rates can bring in the same tax revenue.

a) Why do two tax rates yield the same tax revenue on the Laffer curve?

b) Label the two points on the Laffer curve graph that yield 0 tax revenue.

i) Why do these two points yield 0 tax revenue?

v) List three economic “signs” that the economy and government policy is currently in the prohibitive zone.

1)

2)

3)

vi) List three government policies that will push the economy right toward redistribution and three polices that will push the economy to the left on the Laffer curve toward economic growth.

RIGHT: LEFT

1) 1)

2) 2)

3) 3)

vii) What is the crucial assumption behind dynamic scoring?

viii) What is the crucial assumption behind static scoring?

xi) Draw the static scoring graph. LABEL EVERYTHING!

Question 2: Externalities [10 Points]

A) Positive Externality

i) Draw the positive externality (the social benefit curve) on the graph above. Be sure and show the price and quantity along with the marginal social cost curve

ii) On the graph, show how the government corrects for the negative externality by levying a Pigou tax on the polluting firm.

iii) Can the government create an externality by solving an externality? Give an example.

iii) List two problems with the idea of externalities as a method of evaluating market failure in the private economy.

1)

2)

Question 3: Tax Pot Pouri [10 Points]

1) What is a tax Bracket? Give an example

2) What is the purpose of making a tax system “progressive”?

3) Below are two tax rates. Calculate the tax on gross income and calculate the resulting net income for both tax rates.

Tax rate Gross Income Tax Net Income

70% $100

10% $100

4) Now, assume the government cuts taxes on both tax rates by 50%. Calculate the tax and net income for both rates.

Tax Rate Gross Income Tax Net Income

10% $100

5% $100

5) What is the difference between the net income in #3 and #4 for both tax rates? Which rate has the most incentive to work, save and invest?

6) Look up Estonia’s Personal Income Tax System and write the brackets and accompanying tax rates.

NOTE: Found at http://taxsummaries.pwc.com/ID/Estonia-Individual-Taxes-on-personal-income

a) Is this a Progressive Tax System? If not, what kind is it? How do you know?

Question 4: Income Tax Calculation for Sweden [10 points]

Instructions: Sweden is known for having an extensive array of positive benefits provided to their citizens [education, health care, national pension fund, generous unemployment, ect]. However, these benefits are costly.

a) Below are the actual taxes paid for a Swedish citizen earning 77,000 dollars a year [US DOLLARS] living in the capitol of Stockholm Sweden [taken from the Swedish government’s version of the Internal Revenue Service].

INSTRUCTIONS:

a) using the “Net Taxable Income” number calculate each tax listed

b) add up the taxes to arrive at a total tax figure

c) then subtract the total tax from the “Net Taxable Income” number to arrive at the “Net Income” figure (the amount you actually see on your pay check)

List of Taxes Paid by the average Swedish wage earner on income:

Municipal Tax Rate 19.09143%

County Tax Rate 12.02397%

High Tax Rate .059364%

Federal Income Tax

plus Social Security Tax 32.1059%

b) Gross income per month for 77, 000 dollars a year is 6,416 dollars per month [77,000/12 months]. What is the net income the Swedish individual actually receives in his paycheck per month after taxes?

c) What percent of gross income is net income?

d) What is the tax wedge in this problem?