Exercises: The welfare state and taxes

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

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

A bicycle costs $\$400$ excluding sales tax and the standard rate of $21\ \%$ is applied.

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

Make a list of five things you use or benefit from that are paid for with taxes, even if you do not notice (the paved street, your school, the health clinic, the fire department, the recreation center). Explain why taxes are said to be "the price of shared services".

What is the tax rate? Calculate how much is paid with a rate of $10\ \%$ on taxable income of $\$1,000$ and with a rate of $21\ \%$ on the same income. What is the difference between the taxable income and the tax due?

Taxes can levy income, consumption or wealth. Classify the following: sales tax, federal income tax (personal income tax), the property tax and inheritance tax. Explain what each one is levied on.

In Spain, not everything has the same VAT: there is a standard rate ($21\ \%$), a reduced rate and a super-reduced rate. Explain why bread, medicines or books have lower rates than a cell phone or a television: what fiscal policy criterion lies behind it?

What are Social Security and Medicare, and what do they fund in the United States (retirement benefits, part of healthcare, unemployment benefits)? Explain who contributes (employer and worker) and why it is described as a compulsory collective insurance.

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

1. a) Calculate how much a person earning $\$10,000$ and another earning $\$30,000$ 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 income of $\$15,000$ is taxed as follows: $0\ \%$ on the first $\$10,000$ and $15\ \%$ on whatever exceeds $\$10,000$.

1. a) Calculate the total tax due.
2. b) Calculate the effective average rate and explain why it is lower than the $15\ \%$ (marginal rate) paid on the last bracket.

The federal government needs to raise more revenue and is hesitating between raising the sales tax on movie tickets or creating a tax on large fortunes.

1. a) Analyze who is affected by each option (incidence): who goes to the movies and who owns large fortunes?
2. b) Compare both options using the criteria of expected revenue and equity, and reason what data you would need to decide.

A state creates a deduction in state income tax for young people's rent.

1. a) What objective does the tax incentive pursue?
2. b) Anticipate a frequent unintended effect of housing aid (it gets passed on to rental prices) and explain when this happens.
3. c) How would you evaluate whether the deduction has worked? State indicators and the comparison.

The tax on sugary drinks is paid at source by the distributor, but the price on the shelf rises by almost the whole tax.

1. a) Explain how a tax is passed on to the price and who bears it in the end.
2. b) What does it depend on whether the store can pass it on in full or has to absorb part of it (think about the elasticity of demand)?
3. c) Analyze who bears this tax more, in proportion to their income: is it progressive or regressive? Justify your answer.

Distinguish between tax avoidance (exploiting legal loopholes to pay less) and tax evasion (hiding income, which is a crime). Give an example of each and explain why some people's fraud ends up being paid for by the rest of the taxpayers (fewer services or higher taxes for everyone).

An annual salary of $\$24,000$ is taxed in brackets: $0\ \%$ up to $\$12,000$, $20\ \%$ from $12,000$ to $\$20,000$, and $30\ \%$ above $\$20,000$.

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

In a congressional debate on taxation, one member of Congress 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 member of Congress 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 representative'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 representative would be right and under what conditions the second would be right.
3. c) Imagine you are advising the Treasury Department: 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 a sales tax on movie tickets and a sales tax 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 adviser.

You are asked to design the personal income tax of a fictitious country with three objectives: raise enough revenue, be progressive, and not punish effort with sky-high marginal rates.

1. a) Propose a tax bracket table with specific rates and justify it.
2. b) Calculate how much an income of $\$20,000$ and one of $\$60,000$ would pay under your table, and the resulting average rates.
3. c) Defend the degree of progressivity you chose against a flat tax rate of $25\ \%$.

A CO₂ tax that makes fossil fuels more expensive is proposed. Low-income households spend a larger share of their budget on energy.

1. a) Explain the regressivity problem of the tax.
2. b) Design compensation mechanisms (an annual green check equal for everyone, cuts to other taxes on labor) and reason how they can make the reform environmental and fair at the same time.
3. c) Evaluate your design: does it still encourage saving energy after the compensation? Justify your answer.