3) Imagine the following scenario. Gaetano picks olives from his tree and sells

Question

3) Imagine the following scenario. Gaetano picks olives from his tree and sells them to Fred for $5. Fred takes the olives and presses them into olive oil, which he sells to Wong for $7. Wong packages the olive oil and he displays it in his store, on sale for $10, where Nathan buys the bottle of olive oil.

a) If the tax system is a retail sales tax system, and the tax rate is 20% (exclusive), who pays the tax and what is the total amount of tax paid?

b) If the tax system is a VAT system with credits, and the tax rate is 20% (exclusive), who pays the tax and what is the total amount of tax paid? (It will help if you keep track of the credits. You can consult the VAT.gif image on Canvas or the Slemrod & Bakija reading (see below) for help on this.)

c) Which system do you think will lead to less tax evasion, and why?

Explanation / Answer

(a)If the tax is a retail sales tax system and the tax rate is 20% Wong pays the taxes as he is the final seller from whom the product is purchased by the final consumer. The amount of tax paid is 20% on $10 which is $ 20/100 *10 = $2

(b). If the tax system is a VAT system with credits and the tax rate is 20% the tax is paid by Fred and Wong. The amount of tax paid by Fred is 20% of 7 = $1.4 and the amount of tax paid by Wong is 20% of 10 = $2. VAT tax is based on the value added to the product. Hence, Gaetano will not be paying the tax since he is picking olives from his tree and directl selling it.

(c). VAT system will lead to less tax evasion as the burden of tax falls on every successive stage of sales from production to packaging to final sales.

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