Chapter 11
Contractionary fiscal policy
Contractionary fiscal policy refers to decreases in government expenditures and/or increases in taxes to achieve particular economic goals
A progressive income tax always raises more revenue than a proportional income tax. Do you agree or disagree? Explain your answer.
Disagree. A progressive income tax can become burdensome on work effort and result in smaller tax collections than a proportional tax. For example, a 100 percent tax on all income above $100,000 would be highly progressive, and drive down work effort as well.
Discretionary fiscal policy
Discretionary fiscal policy occurs when changes in government expenditures and taxes are brought about deliberately through government actions
According to Buchanan and Wagner, why is there a political bias towards expansionary fiscal policy and not contractionary fiscal policy?
Expansionary fiscal policy is likely to be more popular among the citizens than a contractionary policy. If the political environment is such that the people do not want the government to reduce spending benefits or raise taxes, then the government is less likely to introduce these measures. Economic policies often have political dimensions and politics often trumps economics.
An interesting Fact: Taxing Millionaires and teh Budget Deficit
It is often believed that taxing the rich at a higher rate would help in reducing or eliminating budget deficits. Two important questions to consider in this case would be the rate at which the rich would have to be taxed to eliminate the deficits and the number of years in which the deficit can be eliminated by taxing the rich at a higher tax rate.
Fiscal Policy and Expectations
Tax rate changes may not induce changes in people's behaviors if they expect even larger tax rate changes in the future.
Fiscal Policy- Keynesian Perspective (Economy is not seld Regulating)
The Keynesian prescription for a recessionary gap is to enact expansionary fiscal policy measures (an increase in government purchases or a decrease in taxes) to shift the AD curve rightward to move the economy to the Natural Real GDP level. The Keynesian prescription for an inflationary gap is to enact contractionary fiscal policy measures (a decrease in government purchases or an increase in taxes) to shift the AD curve leftward to move the economy to the Natural Real GDP level.
Federal Budget
The federal budget is composed of two, not necessarily equal, parts: government expenditures and tax revenues. Government expenditures is the sum of government purchases and (government) transfer payments.
Two Important NOtes
This chapter deals only with discretionary fiscal policy, and assumes that transfer payments are constant so that changes in government spending are a reflection of changes in government purchases only.
Define Public Debt
1. The public debt is the total amount the federal government owes its creditors.
What is the difference between a structural deficit and a cyclical deficit?
A cyclical deficit will disappear when the economy returns to full-employment, while a structural deficit will not.
What is the difference between a marginal tax rate and an average tax rate?
A marginal tax rate is the rate paid on additional income while an average tax rate is the rate paid on all income.
Tax Deductions vs Subsidies
A tax subsidy is not the same as a tax deduction. With a subsidy, money goes from one person to another. If a company is being subsidized, the government takes money from the taxpayers and gives it to the company receiving a subsidy. A tax deduction occurs when the government reduces the taxes to be paid by a company if the company does something like keeping its factories in the U.S.
Will tax cuts that the public perceives to be temporary affect the SRAS and LRAS curves differently than tax cuts that are perceived to be permanent? Explain your answer.
A temporary tax cut will not alter people's work behavior because it is temporary and may not impact SRAS, and should not impact LRAS at all. A permanent decrease in taxes should result in a permanent change in the behavior of people toward greater work effort, resulting in permanent rightward shifts of both the SRAS curve and the LRAS curve.
Define value-added tax (VAT).
A value-added tax (VAT) is a tax applied to the value added at each stage of production.
Tax cuts may either decrease or increase tax revenues. Do you agree or disagree? Explain your answer.
Agree. Tax revenues may increase or decrease based on how much the tax base changes when the average tax rate is changed. Tax revenues = Tax base × (average) Tax rate For example, a tax rate of 10 percent multiplied by a tax base of $100 billion generates $10 billion of tax revenues. If the tax rate is reduced to 8 percent, the reduction is likely to increase the tax base to $110 billion. Tax revenues drop to $8.80 billion. But, if the tax base expands to $130 billion, the tax revenues rise to $10.4 billion.
Income Tax structures
An income tax structure can be progressive (the tax rate increases as a person's taxable income level rises), proportional (the same tax rate is used for all income levels), or regressive (the tax rate decreases as a person's taxable income level rises).
Give a numerical example to illustrate the difference between complete crowding out and incomplete crowding out.
Answers will vary. An example of complete crowding out would be if the government spends $1 million on food stamps and spending by food stamp recipients falls by $1 million. An example of incomplete crowding out would be if the government spends $1 million on food stamps and spending by food stamp recipients falls by $0.8 million.
Automatic fiscal policy
Automatic fiscal policy occurs when a change in either government expenditures or taxes takes place in response to economic events
Explain why some critics prefer a sales tax to a VAT.
Critics stress the point that VAT is less visible than a sales tax, making it hard for consumers to distinguish between the seller charging a higher price because the VAT rate has been raised and the seller charging a higher price even without the VAT rate being raised.
Explain two ways crowding out may occur
Crowding out may occur because individuals substitute government goods for private goods or because financing the deficit pushes interest rates upward causing investment to fall.
Supply Side Fiscal Policy
Fiscal policy effects may be felt on the supply side as well as the demand side of the economy. Supply-side fiscal policy focuses on taxation issues.
Will tax revenue necessarily rise if tax rates are lowered? Explain your answer.
No. The answer depends on how the change in the tax rate affects the tax base. If the tax rate cut does not cause a large enough increase in the tax base, then tax revenue will fall.
The bulk of federal government expenditures go for four programs. What are they?
Social security, Medicare, Medicaid, and national defense account for the bulk of government expenditures.
Give a numerical example to illustrate the difference between the marginal tax rate and the average tax rate.
Taxable Income $100 $110 Tax Payment $10 $12 Marginal tax rate = Δ Tax payment/Δ Taxable income = $2/$10 = 20% Average tax rate = Tax payment/Taxable income = $10/$100 = 10%
Describe the Keynesian prescription to cure a recessionary gap
The Keynesian prescription to cure a recessionary gap would be to increase government purchases or decrease taxes to shift the AD curve rightward to eliminate the gap.
Identify and explain the five lags associated with fiscal policy
The five types of lags include the data lag (policymakers are not aware of changes in the economy as soon as they happen); the wait-and-see lag (policymakers rarely enact counteractive measures immediately); the legislative lag (it can take months for policymakers to propose a fiscal policy measure, build support for it, and get it passed); the transmission lag (fiscal policy measures take time to be put into effect); and the effectiveness lag (after a policy measure is implemented, it takes time to affect the economy).
Demand Side fiscal policy
This section focuses on how government spending and taxes can affect aggregate demand.
Budget Projections
This section presents the projections for government spending and tax revenues from 2015 to 2019.
Why is crowding out an important issue in the debate over the use of fiscal policy?
Those who advocate the use of fiscal policy believe it is capable of affecting the aggregate demand curve and therefore Real GDP. Crowding out calls the effectiveness of fiscal policy into question. For example, if an increase in government purchases causes private expenditures to fall by the same amount, then there is complete crowding out and the aggregate demand curve does not shift. Thus, there is no change in Real GDP.
What is the difference between discretionary fiscal policy and automatic fiscal policy?
When changes in government expenditures and taxes are brought about deliberately through government actions, fiscal policy is said to be discretionary. In contrast, a change in either government expenditures or taxes that occurs automatically in response to economic events is referred to as automatic fiscal policy.
Explain the difference between zero, incomplete, and complete crowding out. If crowding out is complete, does it call into question the effectiveness of a rise in government purchases in order to remove an economy from a recessionary gap? Explain and diagrammatically represent your answer.
Zero crowding out: The government increases spending but private sector spending remains constant. Incomplete crowding out: The government increases spending and there is a less than proportionate decrease in private sector spending. Complete crowding out: The government increases spending and there is an equal decrease in private spending. In the above figure, the economy is in a recessionary gap at point 1. A fall in private expenditures completely offsets the initial increase in aggregate demand due to increased government spending. The aggregate demand curve does not move (on net) at all. Real GDP does not change, and neither does the unemployment rate. So, with complete crowding out, expansionary fiscal policy has no effect on the economy. The economy remains at point 1.
The federal budget can be in deficit in surpolus or in balance, and there can be a cyclical and a structural deficit Explain when each of the following would occur: Budget deficit bedget surples balanced budget cyclical deficit structural deficit
a. A budget deficit would occur if government expenditures exceeded tax revenues in a given fiscal year. b. A budget surplus would occur if government expenditures were less than tax revenues in a given fiscal year. c. A balanced budget would occur if government expenditures equaled tax revenues in a given fiscal year. d. A cyclical deficit is the part of the federal budget deficit that occurs as a result of an economic downturn. e. A structural deficit is the part of the federal budget deficit that would exist if the economy were operating at full employment.
Data Lag
the time between when a potential problem arises and when policymakers notice it.
Wait and See Lag
the time between when policymakers notice a potential problem and when they decide it is worthy of action.
Legislative Lag
the time it takes to get a policy action approved
Transmission Lag
the time required to put a policy into effect.
Taxable Income 1,000-5,000 5,001-10,000 10,001-15,000 Taxes 10% of taxable income $500+12% of everything over $5,000 $1,100 + 15% of everything over $10,000 1.) If a person's income is $6,000, how much does he pay in taxes? 2.) If a person's income is $14,000, how much does she pay in taxes? 3.) What is the marginal tax rate on teh 10,001st dollar. What is the marginal tax rate on teh 10,000th dollar? 4.) What is the average tax rate of someone with a taxable income of $13,766
1.) He pays $500 plus 12% of $1,000 = $500 + $120 = $620. 2.) She pays $1,100 plus 15% of $4,000 = $1,100 + $600 = $1,700. 3.) On the 10,000th dollar, taxes are $500 + 12% of $5,000 = $1,100 On the 10,001st dollar, taxes are $1,100 + 15% of $1 = $1,100.15 The marginal rate on the 10,001st dollar is 15%. The marginal rate on the 10,000th dollar is 12 percent. 4.) The taxes paid are $1,100 + 15% of 3,766 = $1,664.90. That is an average tax rate of $1,664.90/$13,766 = 12.09%.
The debate over using government spending and taxing powers to stabilize the economy involves more than technical economic issues. Do you agree or disagree? Explain your answer.
Agree. Two technical issues that divide economists have to do with crowding out (Is there crowding out or not?) and the existence and importance of lags (Are there lags? To what degree do they diminish the effectiveness of fiscal policy? Are there ways to get around them?). Besides disagreeing on technical points, economists may disagree as to the ethical decision to run budget deficits, the long-run political consequences of permitting government to run continuous annual deficits, and much more. Simply put, economic debates are not always strictly limited to technical economic issues.
Who pays the income tax?
Economists often look at the tax situation for different income groups, as shown in the text. For example, in 2011, the top 1 percent of income earners in the U.S. earned 18.7 percent of the income earned that year and paid 35.1 percent of the total federal income taxes collected.
Expansionary fiscal policy
Expansionary fiscal policy refers to increases in government expenditures and/or decreases in taxes to achieve particular economic goals.
Democracy in Deficit
In their book Democracy in Deficit, economists James Buchanan and Richard Wagner pointed out that the unwritten balanced budget rule was cast aside with the advent of the Keynesian revolution in economics. Although Keynesian economics might argue for contractionary fiscal policy during an inflationary gap, politics often trump economics and this would lead to a push for expansionary fiscal policy even during an inflationary gap.
Explain why lags are problems.
Lags are problems since, by the time the full impact of the policy is felt, the economic problem it was designed to solve may no longer exist, may not exist to the degree it once did, or may have changed altogether.
Georgia Dickens is sitting with a friend at a coffee shop and they are talking about the new tax bill. Georgia thinks that cutting tax rates at this time would be wrong: "Lower tax rates," she says, "will lead to a larger budget deficit, and the budget deficit is already plenty big." Do lower tax rates mean a larger deficit? Why or why not?
Lower tax rates do not necessarily lead to a larger deficit. Lower tax rates could lead to higher tax revenues which would lead to a smaller budget deficit. What matters is whether the percentage cut in tax rates is larger or smaller than the percentage rise in the tax base.
Jim favors progressive taxation and equal after-tax pay for equal work. Comment.
Progressive taxation is sometimes inconsistent with equal after-tax pay for equal work. To illustrate, suppose each of two persons is paid $1,000 for doing the same job. If the two individuals do not pay the same marginal tax rate, then one individual is left with less after-tax pay for doing the same job the other person does. Simply put, sometimes you have to choose between progressive taxation and equal after-tax pay for equal work.
Name and describe the five types of lags.
The five types of lags include the data lag (policymakers are not aware of changes in the economy as soon as they happen); the wait-and-see lag (policymakers rarely enact counteractive measures immediately); the legislative lag (it can take months for policymakers to propose a fiscal policy measure, build support for it, and get it passed); the transmission lag (fiscal policy measures take time to be put into effect); and the effectiveness lag (after a policy measure is implemented, it takes time to affect the economy).
Explain how, under expansionary fiscal policy, expansionary fiscal policy can, , destabilize the economy.
The government has to know a great deal to implement fiscal policy properly, including the true state of the economy, and the values of Natural Real GDP and the MPC. If the government, for example, were to misread the state of the economy as declining when in fact it were not, the implementation of expansionary fiscal policy could turn equilibrium into an inflationary gap.
Marginal Tax Rates and Aggregate Supply
When fiscal policy measures affect tax rates, they may affect the SRAS curve as well as the AD curve. Ceteris paribus, lower marginal tax rates (= Δ tax payment/ Δ taxable income) increase the incentive to engage in work relative to leisure and tax-avoidance activities. As resources shift from leisure to work, short-run AS increases. If the lower marginal tax rates are permanent, then most economists predict that the long-run AS curve will shift to the right as well.
Is it true that, under a proportional income tax structure, a person who earns a high income will pay more in taxes than a person who earns a low income? Explain your answer.
Yes, it is true. Under a proportional income tax structure, the absolute level of taxes someone pays increases, but taxes as a proportion of income remain the same. For example, if the income tax rate were 20 percent, someone earning $20,000 would pay $4,000 in taxes, and someone earning $50,000 would pay $10,000 in taxes. The person earning $50,000 pays more in taxes, but as a proportion of income, she pays the same amount as the person earning $20,000.
Tax cuts will likely affect aggregate demand and aggregate supply. Does it matter which is affected more? Explain in terms of the AD-AS framework.
Yes. If AD and SRAS both increase, real output will increase. However, the effect on the price level depends upon the relative magnitudes of the changes in AD and SRAS. If AD increases by more than SRAS, then the price level will rise. If SRAS increases by more than AD, then the price level will fall., If AD and SRAS increase proportionally, then the price level should remain constant.
Effectiveness Lag
the time the economy takes to respond once a policy is put into effect.
Explain how changes in government purchases and taxes affect aggregate demand.
An increase in G increases AD and shifts the AD curve rightward. An increase in taxes can affect consumption or investment or both and therefore shift AD. For example, a decrease in income taxes increases disposable income, which leads to an increase in consumption and shifts the AD curve rightward.
Shifting the Aggregate Demand Curve
An increase in government purchases (G) increases aggregate demand (AD) and shifts the AD curve to the right. A decrease in G decreases AD and shifts the AD curve to the left. A change in taxes can affect consumption or investment or both and therefore can affect aggregate demand. For example, a decrease in income taxes increases disposable income, which permits individuals to increase their consumption, increasing AD and shifting the AD curve to the right.
Structural and Cyclical Deficits
Economists use the term cyclical deficit to refer to the part of the budget deficit that is a result of a downturn in economic activity. The part of the deficit that would exist if the economy were operating at full employment is called the structural deficit. The total budget deficit equals the sum of the structural and cyclical deficits.
Crowding Out, Lags, and Effectiveness of Fiscal Policy
Economists who believe that the crowding out is zero and that lags are insignificant conclude that fiscal policy is effective at moving the economy out of a recessionary gap. Economists who believe that crowding out is complete and/or that lags are significant conclude that fiscal policy is ineffective in this respect.
Some Relevant Fiscal Policy Terms
Expansionary fiscal policy refers to increases in government expenditures and/or decreases in taxes to achieve macroeconomic goals. Contractionary fiscal policy refers to decreases in government expenditures and/or increases in taxes to achieve these goals. Discretionary fiscal policy refers to changes in government expenditures and taxes that are brought about deliberately through government actions. Automatic fiscal policy refers to a change in either government expenditures or taxes that takes place in response to economic events.
Fiscal policy
Fiscal policy refers to changes in government expenditures and/or taxes to achieve particular economic goals.
How much were government expenditures in2013? How much were government tax revenues in 2013?
Government expenditures equaled $3.685 trillion in 2013. Government tax revenues equaled $2.712 trillion in 2013.
What is the difference between government expenditures and government purchases?
Government expenditures is the sum of government purchases and (government) transfer payments. Government purchases do not include transfer payments.
Budget Deficit, Surplus, or Balance
If government expenditures are greater (less) than tax revenues, the federal government runs a budget deficit (surplus). If government expenditures are equal to tax revenues, the federal government runs a balanced budget. In 2013, the federal government ran a budget deficit of $973 billion. The federal government finances the budget deficit with borrowed funds.
Explain how government borrowing can lead to interest rate changes that create a crowding out effect.
If, as a consequence of deficit spending, the government borrows more funds, the interest rate will rise and investment spending will decline. The drop in investment spending offsets the government spending.
What percentage of total income did the top 10 percent of income earners earn in2011? What percentage of federal income taxes did this group pay in 2011?
In 2011, the top 10 percent of income earners earned 45.4 percent of the total income earned and paid 68.3 percent of the total federal income taxes collected.
Government Tax Revenues
In 2013, government revenues totaled $2.712 trillion; this was equal to 16.7 percent of GDP for the year. The individual income tax, the corporate income tax, Medicare (payroll) and Social Security (payroll) taxes accounted for 88 percent of total government tax revenues for 2013.
Government Expenditures
In 2013, the federal government spent $3.685 trillion, which was 22.7 percent of GDP for that year. Social security, Medicare, Medicaid, and national defense accounted for about 61 percent of all federal government spending in 2013.
Give a numerical example to illustrate the difference between a progressive and proportional income tax structure. Taxible Income 0-$10,000 $10,001-$11,000 $11,001- $12,000 Progressive Tax Rate 10% 12% 14% Proportional Tax rate 10% 10% 10%
In a progressive income tax structure, the marginal tax rate increases as taxable income increases. In a proportional income tax structure, the marginal tax rate is constant as taxable income increases.
Social Security, Medicare, and medicaid in the future
In the year 2050, if tax revenues as a percentage of GDP are expected to be 19 percent, then all of it will have to be spent on Social Security, Medicare, and Medicaid; spending on these three programs is projected to be approximately 19 percent in 2050. The money to support national defense, education, infrastructure, education, and other programs will have to be borrowed.
Describe how lowering marginal income tax rates will affect aggregate supply.
Lowering marginal tax rates increase incentives to work, increasing short-run aggregate supply. If the lower marginal tax rates are permanent, the long-run aggregate supply curve will shift rightward too.
Is crowding out equally likely under all economic conditions? Explain your answer
No. The closer the economy is to its production possibilities frontier (i.e., full employment) and/or the steeper the SRAS curve, the greater the likelihood of significant crowding out. The condition of the financial market is also important. The tighter the supply of money and/or loanable funds, the greater the likelihood of reduced private borrowing in the case of a budget deficit.
Suppose the economy is in a recessionary gap, and both Smith and Jones advocate expansionary fiscal policy. Does it follow that both Smith and Jones favor so-called big government?
Not necessarily. Expansionary fiscal policy only results in permanently larger government if the expenditure increases undertaken to shift the aggregate demand curve are left in place after the need for the policy has passed. Also, Smith may prefer more government spending (bigger government) while Jones prefers tax cuts (smaller government) when it comes to expansionary fiscal policy.
Explain how direct substitution of public services for consumer spending can create a crowding out effect.
One illustration of direct substitution of public services for consumer spending would be if the government buys $60 worth of gasoline for you, you decide to cut back your own spending (on gasoline and all other goods) by $60. In this case, there is a direct substitution of government purchases for consumer spending.
Fiscal Policy
One of the major ways government can influence the economy is through its fiscal policy. Fiscal policy refers to changes in government expenditures and/or taxes to achieve particular economic goals, such as low unemployment, price stability, and economic growth.
Crowding out: Questioning Expansionary Fiscal Policy
Some economists believe that crowding out effect reduces the effectiveness of fiscal policy. Crowding out refers to a decrease in private expenditures that occurs as a consequence of increased government spending or the financing needs of a budget deficit. Crowding out can be direct or indirect. When one dollar of government spending offsets one dollar of private spending, complete crowding out is said to exist. Incomplete crowding out occurs when an increase in government spending is only partially offset by a decrease in private spending. Zero crowding out occurs if an increase in government spending is not offset at all by a decrease in private spending. If complete or incomplete crowding out occurs, fiscal policy will have less impact on aggregated demand and Real GDP than Keynesian theory predicts. Exhibit 3 illustrates the consequences of complete and incomplete crowding out.
Value Added Tax
Some economists have proposed higher taxes or new taxes to deal with the enlarged budget deficits and growing public debt. One tax that has been suggested is the value-added tax (VAT). Some have proposed VAT as a supplementary revenue source; others, as a substitute for current taxes. The value- Added Part Value added is the difference between what a producer sells a (final) good for and what he pays for a (intermediate) good. Two things to be noted here are the following: a. The sum of the values added is equal to the price paid by the final consumer. b. The value added at each stage of production is equal to the dollar amount kept by the seller of the good. The Tax Part- - A value-added tax (VAT) is a tax applied to the value added at each stage of production. VAT generates tax revenue and it raises prices. A VAT generates the same amount of revenue as a sales tax of the same amount, but critics stress the point that VAT is less visible than a sales tax, making it hard for consumers to distinguish between the seller charging a higher price because the VAT rate has been raised and the seller charging a higher price even without the VAT rate being raised. The VAT critics add that when a sales tax is raised, people look to government and say, "Government raised my taxes." When VAT is raised, people say, "Sellers raised the prices I pay."
Describe the Keynesian prescription to cure an inflationary gap.
The Keynesian prescription to cure an inflationary gap would be to decrease government purchases or increase taxes to shift the AD curve leftward to eliminate the gap.
Describe the Laffer Curve, and use it to explain how lower marginal tax rates can lead to higher tax revenues.
The Laffer Curve shows the relationship between marginal income tax rates and total tax revenue. According to the Laffer Curve, as tax rates rise from zero, tax revenues rise, reach a maximum point, and then fall as the tax rate continues to rise. Therefore, depending on where on the Laffer Curve the economy is located, it is possible that if the government lowers marginal income tax rates, tax revenue will actually rise.
The Laffer Curve: Tax Rates and Tax Revenues
The Laffer Curve shows the relationship between tax rates and tax revenues. According to Laffer, as tax rates rise from zero, tax revenues rise, reach a maximum point, and then fall as the tax rate continues to rise. Tax revenues are a function of the tax rate and the tax base, as shown in the equation: Tax revenues = Tax base x (average) Tax rate Whether tax revenues increase or decrease as the average tax rate is lowered depends on whether the tax base expands by a greater or lesser percentage than the percentage reduction in the tax rate. It is possible for tax revenues to increase if (marginal) income tax rates are reduced.
List the major federal government spending programs
The major federal government spending programs include Social Security, Medicare, Medicaid, and national defense.
List the major federal government taxes
The major federal government taxes are the individual income tax, the corporate income tax, and social security taxes.
The Public Debt
The public debt is the total amount the federal government owes its creditors. The public debt was $17.5 trillion on July 30, 2014. The public debt held by the public was $12.5 trillion.
Compare a proportional tax system, a progressive tax system, and a regressive tax system.
The tax rate is constant as income rises under a proportional tax system, rises as income rises under a progressive tax system, and falls as income rises under a regressive tax system.
Lags and Fiscal Policy
There are potentially significant time lags involved in the process of identifying economic problems. Time lags may negate the effectiveness of discretionary fiscal policy by making it take effect too late. In fact, if the policy takes effect late enough, it may actually cause more problems than it solves. There are 5 different lags
Some economists argue for the use of fiscal policy to solve economic problems; some argue against it. What are some of the arguments on both sides?
This answer is given with respect to demand-side fiscal policy only. Those in favor of the use of fiscal policy often argue that the economy is not always self-regulating and that sometimes it needs a push to move it in the right direction. Fiscal policy is that push. Those against the use of fiscal policy often argue that the economy is self-regulating, that the existence of lags can turn a potentially effective fiscal policy measure into the "wrong medicine at the wrong time," and that the existence of crowding out places a question mark over the effectiveness of fiscal policy.
5. A hypothetical society has three income earners, and all three must pay income taxes. The taxable income of Smith is $40,000, the taxable income of Jones is $100,000 and the taxable income of Brown is $200,000. (a) How much tax revenue is raised under a proportional income tax where the tax rate is 10 percent? How much is raised if the tax rate is 15 percent? (b) A progressive system is installed, with a rate of 5 percent on an income of $0-$40,000, a rate of 8 percent on income from $40,001 to $100,000, and a rate of 15 percent on all income over $100,000. Will this system raise more or less tax revenue than a proportional tax rate of 10 percent? Explain your answer.
Total income is $340,000. (a) At a 10 percent flat rate, tax payments would be $34,000; at a 15 percent flat rate, tax payments would be $51,000. (b) With the progressive income tax system specified, tax payments would be $40,000.