4. Redistributive philosophies and incentives Consider a society comprised of tw

Question

4. Redistributive philosophies and incentives Consider a society comprised of two people. Lorenzo earns an income of $120,000 per year and Neha earns an income of $35,000 per year. The government is considering a redistribution plan that would impose a 20% tax on Lorenzo's income and give the revenue to Neha. Without any incentive distortion, Lorenzo would retain $96,000 and Neha would end up with $59,000. However, let us assume that since Lorenzo will not receive all the income he earns, he decides to work less and earn an income of only $110,000, of which will be owed in taxes. With the redistribution plan, Lorenzo will take home an income of _________

. The $22,000 that Lorenzo pays in taxes will be transferred by the government to Neha. Let us assume that since Neha now receives payment from the government, she will not work as many hours and will earn an income from work of only $34,000 instead of her initial $35,000. With the redistribution plan, Neha's total income (including the government received) is now______

. Without a redistribution plan, total income in this society is______

. After the redistribution plan is implemented, total income in this society is______

. Therefore, the redistribution plan total income in this society_______(increases/decreases).

According to the utilitarian political philosophy, the $22,000 transferred from Lorenzo to Neha will benefit Neha than it hurts Lorenzo. Which of the following statements is true according to this philosophy?

A.The government should definitely institute the plan because it will increase overall utility.

B.The government should not institute the plan because it has no right to take money from one person and give it to another.

C. The redistribution may or may not be desirable, depending on the relative magnitude of the utility gain and the efficiency loss.

Explanation / Answer

Answer. Blank 1. Tax = 20% of Lorenzo's income = (20/100)*110,000 = 22,000 = Tax Revenue

So, Lorenzo's income after paying tax = 110,000-22,000 = 88,000

Blank 2. Neha's total income after receiving government's tax revenue = Neha's income + tax revenue = 34,000 + 22,000 = 56,000

Blank 3. Total income in the society = Lorenzo's income + Neha's income = 88,000 + 56,000 = 144,000

Blank 4. Total income in the society before the redistribution plan = Lorenzo's income + Neha's income = 120,000 + 35,000 = 155,000

Total income after redistribution plan = 144,000

So, After the redistribution plan, the total income level in the society decreases.

Blank 5. (C) The redistribution may or may not be desirbale, depending on the relative magnitutde of the utility gain and the efficiency loss.

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