Exercises: The welfare state and taxes

Explain what the welfare state is and what services taxes fund in Mexico. Where does the money for a public school or a public hospital come from?

Distinguish between direct and indirect taxes and classify the following: VAT, personal income tax, corporate income tax, and gas tax. Who pays them and what are they levied on?

A bicycle costs $\$8\,000$ excluding VAT and the standard rate of $21\ \%$ is applied.

1. a) Calculate the VAT and the final price.
2. b) Explain why VAT is considered an indirect tax.

One country has a single tax rate of $20\ \%$ on income; another uses tax brackets: $10\ \%$ up to $\$200\,000$ and $30\ \%$ above that amount.

1. a) Calculate how much a person earning $\$200\,000$ and another earning $\$600\,000$ pay under each system.
2. b) Which system is progressive and which is proportional? Explain the difference.

The figure compares two income taxes: a flat-rate tax and a progressive bracket tax. On the horizontal axis, annual income; on the vertical axis, the effective rate paid.

1. a) Read what effective rate an annual income of $\$40,000$ pays under each system.
2. b) Explain which curve corresponds to each system and what it means that one increases while the other does not.

Explain the principle of solidarity in funding the welfare state and apply it to this case: a healthy person with a good salary pays taxes that fund a hospital they might not set foot in for years. Why do we accept this system?

An annual salary of $\$480\,000$ is taxed in brackets: $0\ \%$ up to $\$240\,000$, $20\ \%$ from $240\,000$ to $\$400\,000$, and $30\ \%$ above $\$400\,000$.

1. a) Calculate the total tax and the effective average rate.
2. b) Compare the average rate with the marginal rate (the rate paid on the last pesos earned) and explain why confusing them leads to mistakes in public debate.

In a parliamentary debate on taxation, one member of parliament states: "If we raise the top marginal income tax rate from $45\ \%$ to $60\ \%$, revenue will fall because high earners will stop making an effort or leave the country." Another MP replies: "On the contrary, to maintain their net standard of living after tax, professionals will have to work even more hours, so we will collect more."

1. a) Identify the two opposing microeconomic effects (substitution effect and income effect) underlying each MP's argument and explain how each affects the labor supply.
2. b) Use the logic of the Laffer curve to predict under what empirical conditions the first MP would be right and under what conditions the second would be right.
3. c) Imagine you are advising the Ministry of Finance: what empirical variables or indicators (labor supply elasticity, international tax mobility, avoidance opportunities) would you ask to analyze before setting that $60\ \%$ rate, comparing it to a moderate rate of $20\ \%$?

The government is considering raising a tax and is deciding between VAT on movie tickets and VAT on sugary drinks.

1. a) Analyze each option using three criteria: expected revenue (think about the elasticity of demand), health impact, and equity (who is affected most).
2. b) Decide on and defend your proposal as if you were the tax advisor.