Joe has a private legal business, and earns $50 per hour. At a tax rate of 0%, h
ID: 1163715 • Letter: J
Question
Joe has a private legal business, and earns $50 per hour. At a tax rate of 0%, he works 20 hours per week. At a 25% tax rate he works only 16 hours per week, and at a 40% tax rate he works only 8 hours per week. Mark works in manufacturing, and earns $6 per hour. He works 20 hours per week regardless of the tax rate. The government is considering imposing an income tax of either 25% or 40% on Joe and using the revenue to make transfer payments to Mark. The table below summarizes the three possible policies.
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5. Joe has a private legal business, and earns $50 per hour. At a tax rate of 0%, he works 20 hours per week. At a 25% tax rate he works only 16 hours per week, and at a 40% tax rate he works only 8 hours per week. Mark works in manufacturing, and earns $6 per hour. He works 20 hours per week regardless of the tax rate. The government is considering imposing an income tax of either 25% or 40% on Joe and using the revenue to make transfer payments to Mark. The table below summarizes the three possible policies. 0% $1,000 $0 Joe's pre-tax income Joe's taxes Joe's net income Mark's pre-tax income Mark's transfer payment Mark's net income 25% $800 $200 600 $120 $200 S320 40% $400 $160 240 $120 $160 $120 $0 $120 Suppose that Joe and Mark have the same utility function, U(Y)-Y45, where Y is consumption (which is equal to net income) a) Rank the three tax policies for a utilitarian social welfare function, and again for a Rawlsian social welfare function. b) How would your answer change if the utility function was instead U(Y)-Y15 c) Suppose Joe and Mark instead have different utility functions: Joe's utility is given by U(Y)- (/)Y23, and Mark's is given by U(Y)-Y25. (This might happen, for example, because Joe has significant disabilities and therefore needs more income to get the same level of utility.) How would a Rawlsian rank the three tax policies now?Explanation / Answer
Answer:
a.
If the policies increase or decrease the social welfare depends on the society's taste for reallocation. Certainly, each of the policies makes ted better off and make the bill worse off than the status quo of no taxes. So if society deems it sufficient important to posting to ted, then any of the policy would raise the social welfare.
If society cares about only the size of the pie, then both the policies would lower the social welfare. When the society believes in improving the ted income by $200, improves the social welfare more than decreasing bill income by $400 damages the social welfare, then the 25% tax policy increase the social welfare and the optimal policy. Thus, the 40% tax policy can never be optimal, because the 25% tax policy makes both bill and ted better-off than the 40% tax policy.
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