Suppose the welfare benefit formula is Benefit = $4,800 – 0.67 (Wages > $6,000)

Question

Suppose the welfare benefit formula is Benefit = $4,800 – 0.67 (Wages > $6,000) Instructions: Enter your responses as a percent to the nearest whole number.

(a) What is the marginal tax rate on

(i) The first $6,000 of wages? %

(ii) Wages above $6,000? %

(b) How large is the benefit if wages equal Instructions: Enter your responses rounded to the nearest whole number.

(i) $0? $

(ii) $4,500? $

(iii) $9,500? $

(c) What is the breakeven level of income in this case? Instructions: Enter your response rounded to two decimal places. $

Explanation / Answer

The welfare benefit formula is as follows -

Benefit = $4,800 - 0.67(wages>$6,000)

The above formula states that 2/3rd of wages above $6,000 would be subtracted from maximum benefit to ascertain the quantum of benefit an individual will get.

Since, 2/3rd of wages above $6,000 or 67% of wages above $6,000 is subject to subtraction with respect to calculation of benefits, it can be implied that any dollar earned above $6,000 will be subjected to a marginal tax rate of 67%.

However, upto wage of $6,000 there will be no subtraction. So, marginal tax rate upto wage of $6,000 will be 0%.

It should also be noted that as there will be no subtraction upto wage of $6,000, person will get the maximum benefit if his or her income is upto $6,000.

(a) (i) Thus, the marginal tax rate on the first $6,000 of wages is 0%.

(ii) Thus, the marginal tax rate on the wages above $6,000 is 67%.

(b) (i) As stated above, for any wage upto $6,000, there will be no subtraction and person concerned will get the maximum benefit that is $4,800.

So, if wage is $0, then benefit will be $4,800.

(ii) As stated above, for any wage upto $6,000, there will be no subtraction and person concerned will get the maximum benefit that is $4,800.

So, if wage is $4,500, then benefit will be $4,800.

(iii) Wage = $9,500

This wage rate exceeds $6,000 by $3,500.

Calculating Benefit -

Benefit = $4,800 - 0.67($3,500)

Benefit = $4,800 - $2,345

Benefit = $2,455

So, if wage is $9,500 then the benefit will be $2,455.

(c) Calculate the break-even level of income -

Brek-even level of income = Maximum benefit/Marginal tax rate

Break-even level of income = $4,800/0.67

Break-even level of income = $7,164.18

The break-even level of income is $7,164.18

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