Question

The nation of Upstandia uses kroner for money and its tax code is such that a person making 100,000 kroner per year pays 40,000 kroner per year in income taxes; a person making 200,000 kroner per year pays 70,000 kroner per year in income taxes; and a person making 300,000 kroner per year pays 90,000 kroner per year in income taxes. Upstandia's income tax system is: a. Progressive. b. Regressive. c. Proportional. c. Proportional.

Short answer

The tax system in Upstandia is regressive.

Step-by-step solution

Understanding the Definitions

First, we should understand the different types of tax systems. A progressive tax system means that the tax rate increases as the income level increases. In a regressive tax system, the tax rate decreases as the income level increases. A proportional tax system maintains the same tax rate for all income levels.

Calculate the Tax Rate for 100,000 kroner

A person earning 100,000 kroner pays 40,000 kroner in taxes. Calculate the tax rate:\[\text{Tax rate} = \left( \frac{40,000}{100,000} \right) = 0.4 \text{ or } 40\%.\]

Calculate the Tax Rate for 200,000 kroner

Next, for a person earning 200,000 kroner who pays 70,000 in taxes:\[\text{Tax rate} = \left( \frac{70,000}{200,000} \right) = 0.35 \text{ or } 35\%.\]

Calculate the Tax Rate for 300,000 kroner

Finally, for a person earning 300,000 kroner and paying 90,000 in taxes:\[\text{Tax rate} = \left( \frac{90,000}{300,000} \right) = 0.3 \text{ or } 30\%.\]

Determine the Type of Tax System

Looking at the calculated tax rates, as the income increases from 100,000 to 300,000 kroner, the tax rate decreases from 40% to 30%. This decrease in the tax rate suggests a regressive tax system since higher income earners pay a lower percentage of their income in taxes.

Key concepts

Progressive Tax

A progressive tax system is one where the tax rate increases as the taxable income increases. This means the more you earn, the higher percentage of your income you pay in taxes. The idea behind this system is to ensure a fair distribution of the tax burden, rather than having everyone pay the same rate.
With progressive taxes, there are usually tax brackets. Each bracket has its own rate, which gets higher as the income ranges go up. This way, taxpayers who earn higher incomes can afford to pay more, so they get taxed at a higher rate for the upper portion of their income.
For instance:

• If you earn $50,000, you might pay a lower rate than someone earning $100,000.
• Only the income that falls within a specified bracket is taxed at that specific bracket’s rate.

By implementing this system, a government can achieve greater equity in taxation and reduce income inequality. In summary, in a progressive tax system, the burden of taxation increases as income rises.

Regressive Tax

In a regressive tax system, the tax rate decreases as the taxable income increases. This means that lower-income individuals pay a higher percentage of their income in taxes compared to higher-income earners. Essentially, as your income grows, you pay less in terms of percentage, which can put more strain on those who earn less.
Our original exercise with Upstandia reflects a regressive tax system. For example:

• A person making 100,000 kroner pays 40% of their income, while someone making 300,000 kroner pays only 30%.
• This indicates a declining tax rate as income increases.

Regressive taxes are often criticized for being unfair because they disproportionately affect the lower-income population. They fail to distribute the tax burden based on the ability to pay. It is important to understand the implications of such a system, as it can widen the gap between the rich and the poor.

Proportional Tax

A proportional tax system, often known as a flat tax, maintains a constant tax rate for all income levels. This means everyone pays the same percentage of their income, regardless of how much they earn. The simplicity of a proportional tax system makes it appealing; however, it also has its downsides.
Under a proportional tax system, a tax rate is fixed – for example:

• Both individuals earning $30,000 and $300,000 pay the same percentage of their income.
• If the rate is set at 20%, then someone who earns $30,000 and someone who earns $300,000 would both pay exactly 20%.

The advantage of this system is its simplicity and transparency. However, critics argue that it can be regressive in nature since it doesn’t consider differing abilities to pay. In essence, proportional taxes do not adjust based on income brackets, potentially placing a larger relative burden on low-income earners.