EC215 Exam 2 Study Guide: Chapter 18

Why has income inequality increased in the US?

-Rapid technological change has decreased the demand for "unskilled" workers relative to "skilled" workers -Expanding international trade has had the same effect -Increased immigration (legal and not) has brought more unskilled workers to the United States -Market characterized by tournament pay; a few people at the top earn very highly -Assortative mating: The tendency for men and women of similar educational backgrounds to marry has increased, which raises income inequality across households -Luck

What are the two types of Transfers? Give examples

1. In-kind. Ex. Food stamps, housing subsidies, public education, medicaid 2. Cash transfers. Ex. Welfare programs, unemployment compensation

What are the three ways in which governments can fail?

1. Rent-seeking 2. Logrolling and rational ignorance 3. Regulatory capture

Define Medicare

A form of medical insurance for the elderly. Administered by the federal government

Define Poverty Line

A level of annual income equal to three times the amount of money necessary to purchase the minimum quantity of food required for adequate nutrition

Define Arrow Impossibility Theorem

A mathematical theorem that holds that no system of voting can be devised that will consistently represent the underlying preferences of voters

Define Excess Burden

A measure of the efficiency loss to the economy that results from a tax having reduced the quantity of a good produced; also known as deadweight loss. Low excess burden is a desirable feature of tax systems. This relates to the elasticity of supply and demand: high elasticities lead to high excess burdens

Define the Public Choice Model

A model that applies economic analysis to government decision making

Define Regressive Tax

A tax for which people with lower incomes pay a higher percentage of their income in tax than people with higher incomes

Define Progressive Tax

A tax for which people with lower incomes pay a lower percentage of their income in tax than people with higher incomes. Taxes in the US are generally progressive

Define Proportional Tax

A tax that constitutes the same percentage of income for lower-income people as for higher-income people

Which of the following is true about distribution of income and wealth in the US over time in the last two decades? A. It became more unequal. B. It became more equal. C. It has not changed. D. It became more unequal and then more equal.

A. It became more unequal

Define Rent Seeking

Attempts by individuals and firms to use government action to make themselves better off at the expense of others. Regulatory capture is an example of this, where a regulatory agency makes decisions benefitting the firm being regulated. Ex. U.S. sugar firms have successfully lobbied the government for a quota on sugar imports, which keeps the price of their product high

Which of the following is not an example of cash transfers to the poor by the government? A. supplemental social security programs B. housing subsidies C. welfare programs. D. unemployment compensation

B. housing subsidies

Because the United States has a progressive tax system, the distribution of income after taking into account the effects of taxes and transfers is: A. less equal than the distribution of before-tax income. B. more equal than the distribution of before-tax income. C. exactly the same as the distribution of before-tax income. D. none of the above.

B. more equal than the distribution of before-tax income

Which of the following would cause the poverty line for a given family to increase by 20 percent from one year to another? A. a 20 percent increase in the family's income B. a 20 percent decrease in the family's income C. a 20 percent increase in the general level of prices D. a 20 percent increase in real national income

C. a 20 percent increase in the general level of prices

The poverty line (poverty level) equals the: A. average income of the bottom one-tenth of all income recipients. B. cost of an economical and nutritional food plan for a family multiplied by six. C. cost of an economical and nutritional food plan for a family multiplied by three. D. average income of a family headed by a worker who has been unemployed for six months or more.

C. cost of an economical and nutritional food plan for a family multiplied by three

Data on the distribution of income among individuals and families in the United States indicate that: A. the power of labor unions and corporations is the major determinant of income inequality. B. the rich stay rich and the poor stay poor from one generation to another. C. much of the inequality in annual income emanates from differences in education, age, hours worked, and family size. D. the difference in annual income emanating from ownership of capital assets is the major source of economic inequality.

C. much of the inequality in annual income emanates from differences in education, age, hours worked, and family size

Data on income inequality in the United States indicate that: A. rich families stay rich and poor families stay poor. B. most poor families never significantly rise above the poverty level, but rich families tend to become less wealthy over time. C. there is substantial mobility among income groupings in the United States. D. the inequality between the rich and poor in annual consumption expenditures is greater than the parallel inequality in annual income.

C. there is substantial mobility among income groupings in the United States

If you pay $400 in taxes when you earn $10,000 and $600 in taxes when you earn $12,000, you are subject to a marginal tax rate of: A. 4%. B. 5%. C. 6%. D. 8%. E. 10%.

E. 10%.

What is the relationship between government failure and market failure?

Government failure is market failure due to government intervention rather than to externalities

Define the Benefits-Received Principle

Holds that governments ought to charge more in taxes to people receiving more benefits from taxes. Funding locally-operated services like snow-plowing and road-maintenance at the local town or county level follows the benefits-received principle. However some government services are designed to help poor people; taxing those people to pay for those services is probably counter-productive. Similarly, it is often difficult to identify exactly which groups are helped by particular government activities

Define the Horizontal Equity Principle

Holds that people in the same economic situation ought to pay similar amounts in taxes. This is not easy to apply in practice. If two people each earn $50,000, horizontal-equity seems to suggest taxing each the same amount. But if one receives the income by working two 40-hour a week jobs, while the other receives the income from a lottery annuity, these two people do not seem to be in the "same economic situation"

Define the Ability-to-Pay Principle

Holds that revenue from taxes ought to mostly be paid by the rich—that is, those who have a higher ability to pay. In practice, this means that people with higher incomes end up paying more taxes, a concept known as vertical equity. Income and wealth do correlate, but not perfectly. Income taxes are progressive, reflecting the ability-to-pay principle

Define Regulatory Capture

In principle, regulatory agencies like the Food and Drug Administration (FDA) exist in order to safeguard consumers, but firms that are significantly affected by regulatory agencies have an incentive to make sure the agencies are "on their side". An agency which is acting more in the interest of the firms it is supposed to regulate has been subject to regulatory capture. Ex. The defunct Interstate Commerce Commission was set up to regulate railroads and trucking firms, but ended up preventing competition in the industry instead

Has inequality in the distribution of income in the United States increased or decreased over​ time?

Income inequality in the US has increased since 1970. US is one of highly unequal countries among advanced countries. However, income inequality figures don't consider the following: Substantial income mobility The effects of government programs meant to reduce poverty

Which type of tax raises the most revenue for the federal​ government?

Individual income taxes

Government spending must be financed somehow; most revenue relies on taxation, including what taxes?

Individual income taxes, social insurance taxes, corporate income taxes, sales taxes, property taxes, excise taxes

Inequality of income is caused by what?

Labor productivity, the productivity of capital owned, technological change, and the extent of international trade

Explain Property Taxes

Most local governments tax homes, offices, factories, and the land they are built on. In the US, this is the largest source of funds for public schools

Explain Sales Taxes

Most state and local governments tax retail sales of most products.

Define Logrolling

Politicians gaining support for their own proposals by offering to support those of their colleagues. Helps explain why sugar quotas continue to exist, even when they benefit relatively few people. The loss of surplus per person to the sugar quota is small; many voters remain rationally ignorant of such "irrelevant" ideas

What are the two viewpoints of the Samaritan's dilemma?

Positive: low income families with transfers helps the poor Negative: Discouraging work incentive of the poor

Define Social Security

Provides cash payments to elderly retired workers, the disabled, and widows/widowers with children. Administered by the federal government

Define Medicaid

Provides health care to poor people. Administered by states, but federally mandated and funded through federal grants

Define Temporary Assistance for Needy Families

Provides various forms of financial assistance for a limited time to poor families. Administered by states, but federally mandated and funded through federal grants

In​ 2012, Congress and President Barack Obama passed legislation raising tax rates on families earning​ $450,000 or more. Did this change in the law make the U.S. tax system more progressive or less​ progressive?

Raising taxes on​ high-earning families will cause the U.S. tax system to become more progressive because those with higher incomes will pay a larger percentage of their incomes in tax

Which type of tax raises the most revenue for state and local​ governments?

Sales Tax

Define Lorenz Curve

Shows the distribution of income by arraying incomes from lowest to highest on the horizontal axis and indicating the cumulative fraction of income earned by each fraction of households on the vertical axis

What are some policies to reduce income inequality?

Taxes and transfers Improving human capital

Define Human Capital

The accumulated knowledge and skills that workers acquire from formal training and education or from life experiences. Since human capital is not distributed equally across workers, neither will income

Define Tax Incidence

The actual division of the burden of a tax between buyers and sellers in a market

Define Voting Paradox

The failure of majority voting to always result in consistent choices

Explain Excise Taxes

The federal government and some state governments levy excise taxes on specific goods like gasoline, cigarettes, and alcohol

Explain Individual Income Taxes

The federal government, most state governments, and some local governments tax the wages, salaries, and other income of households and the profits of small businesses, which are typically taxed the same as wages and salaries.

Define Marginal Tax Rate

The fraction of each additional dollar of income that must be paid in​ taxes. Economists tend to concentrate on marginal tax rates, since these are most relevant for labor supply decisions: they apply to any additional income that people earn

In selecting which taxes to use, governments take into account what goals and principles?

The goal of economic efficiency The ability-to-pay principle The horizontal-equity principle The benefits-received principle The goal of attaining social objectives

Define Corporate Income Taxes

The government taxing corporations on their earnings. These are also progressive, with tax rates from 15% to 35%; but unlike for individuals, most corporate earnings are taxed at the 35% level

Define Gini Coefficient

The larger the area between the actual Lorenz curve and the perfect equality Lorenz curve, the more unequal are incomes. We measure this inequality with the Gini coefficient. Gini coefficient = A/(A+B). Perfect equality in incomes would give a Gini coefficient of 0; if all income was earned by one person, the Gini coefficient would be 1

Is Marginal Tax Rate or Average Tax Rate more important in determining the impact of the tax system on economic behavior?

The marginal tax rate

Define Poverty Rate

The percentage of the population that is poor according to the federal government's definition. Decreases in the poverty rate in the 1960s came largely from the expansion of Social Security.

How has the poverty rate changed in the United States since​ 1960?

The poverty rate has decreased from between 20 and 25 percent in 1960 to between 11 and 15 percent for the past 40 years

Define Median Voter Theorem

The proposition that the outcome of a majority vote is likely to represent the preferences of the voter who is in the political middle

What determines tax incidence?

The relative price elasticities of the demand and supply curves. When the demand for a product is less elastic than the supply, consumers pay the majority of the tax on the product. When demand for a product is more elastic than the supply, firms pay the majority of the tax of the product

Define Average Tax Rate

Total tax paid divided by total income

What are the problems with transfers?

Transfers have expanded substantially. These transfers have been largely ineffective at reducing the poverty rate

True or False: Governments tend to favor taxes that promote social objectives

True

Which of the following taxes best reflects the ability to pay principle? a. sales taxes b. property taxes c. social insurance taxes d. federal individual income taxes

d. federal individual income taxes

Which of the following is a regressive tax? a. federal corporate income taxes b. state individual income taxes c. federal corporate income taxes d. state sales taxes

d. state sales taxes