Chapter 12/The Design of the Tax System ❖ 73
Table 12–16
The table below provides information on the 4 households that make up a small economy and how much they
would pay in taxes under 3 types of taxes.
Household
Ability to Pay
Tax A
Tax B
Tax C
A
low and same as B
100
30
40
B
low and same as A
100
30
50
C
high and same as D
100
40
60
D
high and same as C
100
40
70
69. Refer to Table 12-16. In this economy Tax A exhibits
a.
horizontal and vertical equity.
b.
horizontal equity but not vertical equity.
c.
vertical equity but not horizontal equity.
d.
neither horizontal nor vertical equity.
70. Refer to Table 12-16. In this economy Tax B exhibits
a.
horizontal and vertical equity.
b.
horizontal equity but not vertical equity.
c.
vertical equity but not horizontal equity.
d.
neither horizontal nor vertical equity.
71. Refer to Table 12-16. In this economy Tax C exhibits
a.
horizontal and vertical equity.
b.
horizontal equity but not vertical equity.
c.
vertical equity but not horizontal equity.
d.
neither horizontal nor vertical equity.
72. The most efficient tax possible is a
a.
lump-sum tax.
b.
marginal tax.
c.
proportional tax.
d.
value-added tax.
73. A country is using a proportional tax when
a.
its marginal tax rate equals its average tax rate.
b.
its marginal tax rate is less than its average tax rate.
c.
its marginal tax rate is greater than its average tax rate.
d.
it uses a lump-sum tax.
74 ❖ Chapter 12 /The Design of the Tax System
Table 12–17
The dollar amounts in the last three columns are the taxes owed under the three different tax systems.
Income
Tax System A
Tax System C
$100,000
$20,000
$50,000
$250,000
$50,000
$60,000
$500,000
$100,000
$70,000
74. Refer to Table 12-17. Which of the three tax systems is proportional?
a.
Tax System A
b.
Tax System B
c.
Tax System C
d.
None of the systems are proportional.
75. Refer to Table 12-17. Which of the three tax systems is regressive?
a.
Tax System A
b.
Tax System B
c.
Tax System C
d.
None of the systems are regressive.
76. Refer to Table 12-17. Which of the three tax systems is progressive?
a.
Tax System A
b.
Tax System B
c.
Tax System C
d.
None of the systems are progressive.
77. Refer to Table 12-17. Which of the three tax systems exhibits vertical equity?
a.
Tax System A
b.
Tax System B
c.
Tax System C
d.
All of the systems exhibit vertical equity.
78. The middle quintile of income earners
a.
pays 14.2 percent of income as taxes and pays 9.1 percent of all taxes
b.
pays 9.1 percent of income as taxes and pays 14.2 percent of all taxes.
c.
pays 17.6 percent of income as taxes and pays 16.5 percent of all taxes.
d.
pays 16.5 percent of income as taxes and pays 17.6 percent of all taxes.
Chapter 12/The Design of the Tax System ❖ 75
79. The top 1% of income earners
a.
makes 18.8 percent of all income and pays 28.3 percent of all taxes
b.
makes 27.6 percent of all income and pays 18.1 percent of all taxes.
c.
makes 55.1 percent of all income and pays 68.7 percent of all taxes.
d.
makes 68.7 percent of all income and pays 55.1 percent of all taxes.
80. Economists define a business’s “value added” as
a.
the amount the firm pays for goods and services less the revenue from the sale of goods and
services.
b.
the revenue from the sale of goods and services less the amount the firm pays for goods and
services.
c.
the total value of the goods and services created by the firm.
d.
the value that consumers place on the goods and services created by the firm.
81. Which of the following statements about a value added tax is not correct?
a.
A value added tax is essentially the same as a retail sales tax.
b.
A value added tax is a progressive tax.
c.
A value added tax would provide a source of revenue to fund a large government.
d.
A value added tax is a tax on consumption rather than income.
82. The difference between a value-added tax and a flat tax is
a.
a value-added tax is progressive, while a flat tax is proportional.
b.
a value-added tax is vertically equitable, while a flat tax is horizontally equitable.
c.
a value-added tax satisfies the ability-to–pay principle, while a flat tax satisfies the benefits
principle.
d.
There is essentially no difference between a value-added tax and a flat tax.
THE TRADE-OFF BETWEEN EQUITY AND EFFICIENCY
1. Goals of efficiency and equity in tax policy are
a.
complementary in most countries.
b.
necessary for application of the ability–to–pay principle.
c.
often in conflict with each other.
d.
easier to achieve when tax codes are complex.
76 ❖ Chapter 12 /The Design of the Tax System
2. In choosing the form of a tax, there is often a tradeoff between
a.
allocative and productive efficiency.
b.
profits and revenues.
c.
efficiency and fairness.
d.
fairness and profits.
3. Which of the following tax systems is the most fair?
a.
proportional taxes
b.
regressive taxes
c.
progressive taxes
d.
There is no objective way to assess fairness among the three systems.
4. Economists play an important role in the complex debates over tax policy by
a.
identifying efficiency as the most important goal of tax policy.
b.
identifying equity as the most important goal of tax policy.
c.
shedding light on the tradeoff between efficiency and equity in tax policy.
d.
None of the above is correct.
5. The marginal tax rates on the richest Americans when Ronald Reagan was elected and left office were
a.
28 percent and 50 percent, respectively.
b.
70 percent and 40 percent, respectively.
c.
40 percent and 70 percent, respectively.
d.
50 percent and 28 percent, respectively.
6. In general, Democrats tend to prefer
a.
higher marginal tax rates to promote vertical equity, while Republicans tend to prefer lower
marginal tax rates to promote incentives to work and save.
b.
lower marginal tax rates to promote vertical equity, while Republicans tend to prefer higher
marginal tax rates to promote incentives to work and save.
c.
higher marginal tax rates to promote incentives to work and save, while Republicans tend to prefer
lower marginal tax rates to promote vertical equity.
d.
lower marginal tax rates to promote incentives to work and save, while Republicans tend to prefer
higher marginal tax rates to promote vertical equity.
TRUE/FALSE
1. The average American pays a higher percent of his income in taxes today than he would have in the late 18th
century.
Chapter 12/The Design of the Tax System ❖ 77
2. The government raises revenue through taxation to pay for the services it provides.
3. Most people agree that taxes should impose as small a cost on society as possible and that the burden of taxes
should be distributed fairly.
4. The U.S. tax burden is high compared to many European countries, but is low compared to many other nations
in the world.
5. Less economically developed countries such as India and Pakistan usually have low tax burdens.
6. The U.S. federal government collects about one-half of the taxes in our economy.
7. Revenues from social insurance taxes are earmarked to pay for education and welfare.
8. Government spending is projected to rise over the next few decades. Two of the most important reasons are
spending on Social Security and Medicare.
9. Individual income taxes and social insurance taxes generate the highest tax revenue for the federal govern-
ment.
10. A family’s tax liability is the amount of money it owes in taxes.
11. In the United States, all families pay the same proportion of their income in taxes.
78 ❖ Chapter 12 /The Design of the Tax System
12. A payroll tax is also referred to as a social insurance tax.
13. Individual income taxes generate roughly 25% of the tax revenue for the federal government.
14. Social Security is an income support program, designed primarily to maintain the living standards of the poor.
15. Corporate income taxes are based on the amount of revenue a corporation earns.
16. An excise tax is a tax on a specific good, like gasoline.
17. The largest category of federal spending is national defense.
18. A budget surplus occurs when government receipts fall short of government spending.
19. A budget surplus occurs when government receipts exceed government spending.
20. A budget deficit occurs when government receipts exceed government spending.
21. A budget deficit occurs when government receipts fall short of government spending.
22. One reason for the projected increase, over the next several decades, in government spending as a percentage
of GDP is the projected increase in the size of the elderly population.
Chapter 12/The Design of the Tax System ❖ 79
23. In 2007, state and local government education spending was more than five times highway spending.
24. As of 2007, the largest source of receipts for state and local governments was individual income taxes.
25. Income taxes and property taxes generate the highest tax revenue for state and local governments.
26. As of 2007, the largest source of receipts for state and local governments was corporate income taxes.
27. Sales taxes generate nearly 50% of the tax revenue for state and local governments.
28. Some states do not have a state income tax.
29. By law, all states must have a state income tax.
30. The administrative burden of any tax system is part of the inefficiency it creates.
31. One characteristic of an efficient tax system is that it minimizes the costs associated with revenue collection.
32. The administrative burden of complying with tax laws is a cost to the government but not to taxpayers.
33. The equity of a tax system concerns whether the tax burden is distributed equally among the population.
80 ❖ Chapter 12 /The Design of the Tax System
34. An efficient tax system is one that imposes small deadweight losses and small administrative burdens.
35. Deadweight losses arise because a tax causes some individuals to change their behavior.
36. European countries tend to rely more on consumption taxes than does the United States.
37. If a tax generates a reduction in surplus that is exactly offset by the tax revenue collected by the government,
the tax does not have a deadweight loss.
38. Resources devoted to complying with the tax laws are a type of deadweight loss.
39. An advantage of a consumption tax is that it does not distort the incentive to save.
40. Tax evasion is legal, but tax avoidance is illegal.
41. Tax evasion is illegal, but tax avoidance is legal.
42. In practice, the U.S. income tax system is filled with special provisions that alter a family’s tax based on its
specific circumstances.
43. If Christopher earns $80,000 in taxable income and pays $20,000 in taxes, his average tax rate is 20 percent.
44. If James earns $80,000 in taxable income and pays $20,000 in taxes, his average tax rate is 25 percent.
Chapter 12/The Design of the Tax System ❖ 81
45. If Mary earns $80,000 in taxable income and pays $40,000 in taxes, her marginal tax rate must be 50 percent.
46. Many people consider lump-sum taxes to be unfair to low-income taxpayers.
47. Lump-sum taxes are equitable but not efficient.
48. A lump-sum tax would take different amounts from the poor and the rich.
49. A lump-sum tax minimizes deadweight loss.
50. Deadweight losses and administrative burdens are key factors considered when determining the efficiency of
the tax system.
51. When the total surplus lost as a result of a tax is less than the amount of tax revenue collected by the govern-
ment there is a deadweight loss.
52. The marginal tax rate serves as a measure of the extent to which the tax system discourages people from work-
ing.
53. Most economists believe that a corporate income tax affects the stockholders of a corporation but not its em-
ployees or customers.
54. Antipoverty programs funded by taxes on the wealthy are sometimes advocated on the basis of the benefits
principle.
82 ❖ Chapter 12 /The Design of the Tax System
55. According to the benefits principle, it is fair for people to pay taxes based on the benefits they receive from the
government.
56. According to the benefits principle, it is fair for people to pay taxes based on their ability to shoulder the tax
burden.
57. According to the ability-to-pay principle, it is fair for people to pay taxes based on the amount of government
services that they receive.
58. According to the ability-to-pay principle, it is fair for people to pay taxes based on their ability to handle the
financial burden.
59. If all taxpayers pay the same percentage of income in taxes, the tax system is progressive.
60. If all taxpayers pay the same percentage of income in taxes, the tax system is proportional.
61. Vertical equity refers to a tax system in which individuals with higher incomes pay more in taxes than indi-
viduals with lower incomes.
62. Vertical equity refers to a tax system in which individuals with similar incomes pay similar taxes.
63. Vertical equity is not consistent with a regressive tax structure.
64. Horizontal equity refers to a tax system in which individuals with higher incomes pay more in taxes than indi-
viduals with lower incomes.
Chapter 12/The Design of the Tax System ❖ 83
65. Horizontal equity refers to a tax system in which individuals with similar incomes pay similar taxes.
66. Horizontal and vertical equity are the two primary measures of efficiency of a tax system.
67. A tax system exhibits vertical equity when taxpayers with similar abilities to pay contribute the same amount.
68. To fully understand the progressivity of government policies, one should only look at the proportion of total
income that individuals pay in taxes each year.
69. If the rich pay more in taxes than the poor, the tax system must be progressive.
70. Vertical and horizontal equity are widely accepted and applying them to evaluate a tax system is always
straightforward.
71. A lump sum tax can never have horizontal equity.
72. Horizontal equity can be difficult to assess because it is difficult to compare the similarity of tax payers.
73. Economics alone cannot determine the best way to balance the goals of efficiency and equity.
SHORT ANSWER
1. List the three most important expenditure programs of the federal government. How do they differ from the
three most important expenditure programs of state and local governments? Explain why it makes more sense
for the federal government to purchase “national defense” rather than state governments.
84 ❖ Chapter 12 /The Design of the Tax System
2. A recent increase in federal gasoline taxes was estimated to cause a $150 million reduction in the total surplus
(consumer plus producer surplus) in the gasoline market. If tax revenues increased by $100 million, what is
the deadweight loss associated with the tax? As a result of the tax, 10,000 people sold their cars and started
riding their bicycles to work. How much of the burden of the deadweight loss is incurred by the bicycle riders?
3. Use Table A to complete Table B.
TABLE A
On Taxable Income
The Tax Rate Is
Up to $27,050
15.0%
From $27,051 to $65,550
27.5%
From $65,551 to $136,750
30.5%
From $136,751 to $297,350
35.5%
Over $297,350
39.1%
TABLE B
Taxpayer
Income
Tax Amount
Average Tax Rate
John
$52,700
Todd
$132,500
Glen
$237,000
Jake
$315,250
Taxpayer
Income
Tax Amount
Average Tax Rate
John
$52,700
$11,111.25
Todd
$132,500
Glen
$237,000
$71,949.75
Jake
$315,250
$100,372.90