Download Lecture 9 Efficient and Equitable Taxation

Lecture 9 Efficient and Equitable Taxation
1. According to estimates by Goolsbee and Petrin [2004], the elasticity of demand for basic cable
service is -0.51, and the elasticity of demand for direct broadcast satellites is -7.40. Suppose that a
community wants to raise a given amount of revenue by taxing cable service and the use of direct
broadcast satellites. If the community’s goal is to raise the money as efficiently as possible, what
should be the ratio of the cable tax to the satellite tax? Discuss briefly the assumptions behind
your calculation.
2. In 2002, the US federal government levied a tax of 3 percent on that part of a car’s price
exceeding $40000. (For example, the tax liability on a $50000 car would be 0.03 ×
($50000-$40000), or $300.) Discuss the efficiency, equity, and administrability of this “luxury car
tax.”
3. “Peter the Great at one time levied a tax upon beards. He held that the beard was a superfluous
and useless ornament. The tax is said to have been proportional according to the length of the
beard and progressive according to the social position of its possessor” [Groves, 1946, p.51].
Evaluate Peter’s beard tax from the standpoint of optimal tax theory and from the standpoint of
horizontal equity.
4. In recent years, farmers in China have been protesting their tax treatment by the government.
They have many complaints, including a fee that “is collected for production of ‘special products’
like nuts, even when none are grown” [Eckholm, 1999, p. A10]. Evaluate this nut tax from the
view points of both optimal tax theory and horizontal equity.
5. Diagram a market for a natural monopolist and label the excess burden that results if this firm
produces the profit-maximizing output. Now show the excess burden that results if the firm is
required by law to charge average cost.
6. Suppose that Sharlene faces a marginal income tax rate of 35 percent, and if she cheats on her
taxes, there is a 2 percent chance that she will be caught. Suppose also that the marginal penalty of
tax evasion is 10I, where I is the amount of unreported income (in thousands of dollars). How
much income will Sharlene fail to report?
7. The government provides patents to pharmaceutical companies that allow them to charge high
prices for the drugs they develop for some years. If a company succeeds in developing an effective
drug, the patent protection can result in high profits, especially because the marginal cost of drug
production is low. Some propose that the government raise revenue by levying a one-time tax on
these profits. Would this be an efficient way to raise tax revenue? Include in your answer the
concept of the “time inconsistency of optimal policy.”
8. Indicate whether each of the following statements is true, false, or uncertain, and explain why:
a. A proportional tax on all commodities including leisure is equivalent to a lump sum tax.
b. Efficiency is maximized when all commodities are taxed at the same rate.
c. Average cost pricing for a natural monopoly allows the enterprise to break even, but the
outcome is inefficient.
d. Tom’s workplace provides free access to a fitness room; Jerry’s does not. Horizontal equity
requires that Tom be taxed on the value of having access to the fitness room.