Question

You work for the Council of Economic Advisers, providing economic advice to the White House. The president wants to overhaul the income tax system and asks your advice. Suppose that the current income tax system consists of a proportional tax of \(10 \%\) on all income and that there is one person in the country who earns \(\$ 110\) million; everyone else earns less than \(\$ 100\) million. The president proposes a tax cut targeted at the very rich so that the new tax system would consist of a proportional tax of \(10 \%\) on all income up to \(\$ 100\) million and a marginal tax rate of \(0 \%\) (no tax) on income above \(\$ 100\) million. You are asked to evaluate this tax proposal. a. For incomes of \(\$ 100\) million or less, is this proposed tax system progressive, regressive, or proportional? For incomes of more than \(\$ 100\) million? Explain. b. Would this tax system create more or less tax revenue, other things equal? Is this tax system more or less efficient than the current tax system? Explain.

Short answer

#Answer# Based on the steps in the analysis, for incomes of 100 million or less, the tax system is proportional. For incomes above 100 million, the tax system is regressive. The new tax system generates less revenue than the current tax system. In terms of efficiency, the new tax system can be considered less efficient, as it generates lower revenue and may promote income inequality.

Step-by-step solution

Understand the terms progressive, regressive, and proportional tax systems

Progressive tax system: A system where the tax rate increases as the taxable income increases. Regressive tax system: A system where the tax rate decreases as the taxable income increases. Proportional tax system: A system where the tax rate remains constant regardless of the taxable income.

Determine the tax system for incomes of \(100\) million or less and for incomes above \(100\) million

For incomes of \(100\) million or less, the proposed tax system remains unchanged, with a proportional tax of \(10\%\) on all income. So, for this income range, the tax system is proportional. For incomes above \(100\) million, the marginal tax rate is \(0 \%\) on the income exceeding \(100\) million. This introduces a regressive aspect, as the effective average tax rate decreases for individuals with higher incomes.

Evaluate the tax revenue generated by the proposed tax system compared to the current tax system

Under the current tax system, the person with an income of \(110\) million pays \(10\%\) tax on the whole amount, which is \(11\) million in taxes. With the new tax system, the person with an income of \(110\) million pays \(10\%\) tax on the first \(100\) million, yielding \(10\) million in taxes, and no tax on the income above \(100\) million. All other individuals earning less than \(100\) million are not affected by the tax change. So, the tax revenue generated by the proposed tax system is \(1\) million less than the revenue generated under the current tax system.

Analyze the efficiency of the proposed tax system compared to the current tax system

Efficiency, in this context, refers to the tax system's ability to generate revenue and minimize distortions in the economy. By reducing the tax revenue, the new system is less efficient in generating revenue than the current tax system. Regarding economic distortions, the proposed tax system can encourage individuals to increase their income above the \(100\) million threshold, which may stimulate economic growth. However, it also can lead to income inequality as wealthy individuals accumulate more wealth due to lower tax rates, which can undermine the society's overall well-being. Thus, the efficiency of the new tax system compared to the current one is debatable, depending on other factors in the economy. Overall, it can be considered less efficient since it generates less revenue and introduces income inequality.