6. Understanding marginal and average tax rates Consider the economy of Cocoland
ID: 1111000 • Letter: 6
Question
6. Understanding marginal and average tax rates Consider the economy of Cocoland, where citizens consume only coconuts. Assume that coconuts are priced at $1 each. The government has devised the following tax plans: Plan A . Consumption up to 1,000 coconuts is taxed at 35%. ·Consumption higher than 1,000 coconuts is taxed at 20%. Plan B ·Consumption up to 2,000 coconuts is taxed at 15%. . Consumption higher than 2,000 coconuts is taxed at 60%. Use the Plan A and Plan B tax schemes to complete the following table by deriving the marginal and average tax rates under each tax plan at the consumption levels of 500 coconuts, 1,500 coconuts, and 3,000 coconuts, respectively. Plan A Plan B Consumption Level (Quantity of coconuts) Marginal Tax Rate (Percent) Average Tax Rate Marginal Tax Rate (Percent) Average Tax Rate (Percent) 500 1,500 3,000Explanation / Answer
Marginal tax rate is the tax rate for the tax slab under which consumption falls
Average tax rate = 100 x Total tax revenue/Total consumption
e.g. Plan A : 3000 coconuts are consumed
Tax = 1000 x 35% + (3000 - 1000) x 20% = 750
Average tax rate = 750/3000 x 100 = 25%
Plan B : 3000 coconuts are consumed
Tax = 2000 x 15% + (3000 - 2000) x 60% = 900
Average tax rate = 900/3000 x 100 = 30%
Plan A - regressive (Tax rate decreases as the amount subject to taxation increases)
Plan B - progressive
Plan A Plan B Q MTR (%) ATR (%) MTR (%) ATR (%) 500 35% 35% 15% 15% 1500 20% 30% 15% 15% 3000 20% 25% 60% 30%Related Questions
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