Suppose that there are three types of programs and taxes that apply to individuals with relatively low earnings:
a) Welfare transfer of $3000 paid to those with earnings below $2000 that's then (linearly) eliminated between earnings of $2000 and $8,000 so that people with earnings above $8,000 receive nothing.
b) A progressive tax system that imposes the marginal tax of 15% on earnings between $5,000 and $16,000, and the marginal tax rate of 20% for earnings beyond $16,000 (there is no tax if earnings are less than $5,000).
c) A refundable tax credit that applies to people subject to the tax. It is phased in at the rate of 20% between earnings of $5,000 and $11,000, i.e. the value of the credit increases from $0 when earnings are $5,000 at the rate of 20 cents per dollar of earnings until earnings are equal to $11,000. Then, the full amount of credit applies for those who have earned between $11,000 and $20,000, at which point it starts being (linearly) phased out until earnings reach $32,000.

Questions:

(a) What are the marginal tax rates that combine the effect of all three programs that apply at each of the following earnings levels: $1,000, $4,000, $7,000, $10,000, $12,000, $18,000, $25,000 and $40,000?
(b) After combining all these programs, there is a region where individuals receive a marginal subsidy to earning an extra dollar. Assuming that leisure is a normal good, is it then possible that the combination of all these programs encourages some individuals who would have otherwise not worked to find a job?
(c) Suppose that the credit was instead nonrefundable - the schedule is as described above, but the credit cannot make tax liability negative. Over what range of earnings would the full amount of credit be granted?

(d) Nonrefundability changes the marginal tax rates for some of the earnings levels considered in part (a). Which ones and how?

Answer rating: 100% (QA)

a The marginal tax rate is the total tax liability divided by the total income For e... View the full answer