James Hall.Chapter16

CHAPTER 16: TEST BANK

SOME ANSWERS AND COMMENTS ON THE TEXT DISCUSSION QUESTIONS

1. Replacing the progressive rate structure of the federal personal income tax with a proportional one would make the tax more regressive (or less progressive). However, the various exemptions, deductions, and credits must still be considered. Many people who support a proportional rate structure do so as a means of simplifying the personal income tax. It is really only simplified if the number of exemptions, deductions, and credits are reduced or eliminated. It might be useful to discuss how a proportional tax rate structure could be combined with various exemptions, etc., to make the tax more progressive, and whether this is appropriate.

Secondly, replacing the federal personal income tax with a national sales tax would also make our overall tax structure less progressive, thereby distorting the income distribution in favor of higher income groups. It might be useful to discuss ways in which a national sales tax could be made less regressive, and whether this should be done.

2. People opposed to the estate tax often refer to it as the “death tax”, perhaps implying that since we all must die, we all must pay it, and that a tax on dying is somehow unfair. Clarify that a very small percent of our citizens pay this tax, and that they are primarily very high-income people.

3. It is difficult to be satisfied when social security benefits are provided to high income retired people at the same time we are concerned about the viability of the Social Security program. On the other hand, the Social Security program was set up as a social insurance program, whereby the benefits we receive depend on the amount we have paid into the system. Thus while social security taxes are regressive, the eventual benefits are linked to these contributions, and the benefit structure is progressive.

Nevertheless, it is possible to eliminate the regressivity of the social security taxes. Rather than taxing only income earned through working, all income could be taxed for social security purposes (including capital gains, interest income, dividends, rental income, and so on). This would have the effect of making the social security tax proportional up to the ceiling on income which is taxed. Secondly, this ceiling on income could become a floor instead of a ceiling; that is, all income below that level would not be taxed, while all income above it would be taxed. Finally, benefits might be reduced for higher income individuals and taxes might be fully placed on the benefits to these people. All of these options will clearly raise even more issues!

4. Most economists believe that excise taxes are placed on goods and services because their inelastic demand results in higher government tax revenue. There are also other justifications for excise taxes. The gasoline tax is to be used on highway construction and repair. It is proposed that a higher cigarette tax be imposed (on the grounds that smokers create more medical bills) and be used to finance expanded health care for children. Ask students who smoke whether they would cut down if the price of cigarettes doubles as a result of the tax. Then ask them whether they would cut down on their purchase of soda pop if the price of a 6-pack doubles as a result of an excise tax. Our guess is that your students will not cut down on cigarettes very much, but will cut down on purchases of pop a lot. You can also challenge the concept of a “sin tax” if you wish (imposed because the product is “sinful” or because the product will reap high tax revenue for the government!) What justification could be made for a higher excise tax on alcohol?

5. Students are interested in issues of “fairness”, especially when it comes to their own taxes. Our experience suggests that they favor a proportional tax, because it treats people “equally”. They generally haven’t yet developed the idea that taxes can use to redistribute income within the economy. They also need to think about whether a tax of ten percent of the income of a high income person (for example) is the same as ten percent of the income of a low income person, in terms of its “burden” on the person. Students also seem to like the concept of taxing people who benefit from an activity (e.g., an excise tax on gasoline used for highway repair) or create damage (e.g., an excise tax on cigarettes, alcohol, or pollution).

6. This one is wide open to you and your students!

7. Don’t be surprised if, after your explanation of all the fallacies of comparing the national debt with consumer debt, a number of your students will still tell you that we ought to be concerned about the national debt because it will eventually bankrupt the nation! If they are concerned about the national debt, they should be concerned for appropriate reasons.

SUGGESTED TEST QUESTIONS

Multiple-Choice Questions

1. Government securities consist of: a. the treasury building and the federal reserve system. b. government bonds and treasury bills. c. corporate bonds and stocks. d. All of the above.

2. A tax base is: a. always expressed as a percentage. b. always expressed as some form of income. c. an item that has a tax credit applied to it. d. an item that has a tax rate applied to it.

3. Which tax brings in the greatest share of federal government tax revenue? a. federal personal income tax b. social security tax c. federal excise taxes d. tariffs

4. As of 2001, the federal income tax rate on the very highest increments of income is about: a. 79%. a. 59%. b. 39%. c. 9%.

5. The federal income tax rate on the very highest increments of income at one point reached a high of: a. 90% b. 60% c. 40% d. 20%

6. An amount of money that can be deducted from household income before tax rates are applied is a(n): a. exemption. b. tax credit. c. tax rate. d. tax base.

7. The earned income tax credit: a. is available to low income eligible working people. b. is refundable. c. has increased in recent years. d. All of the above.

8. Excise taxes: a. operate like sales taxes but are applied to only specific goods and services. b. bring in approximately 20% of federal tax revenue. c. bring in approximately 50% of state and local tax revenue. d. All of the above.

9. Which of the following brings in the largest share of state and local taxes? a. property taxes b. sales taxes c. excise taxes d. corporate income taxes

10. A decrease in personal income taxes will cause an increase in: a. disposable income. b. consumption spending. c. aggregate demand. d. all of the above.

11. Which of the following is a regressive tax? a. sales tax b. property tax c. social security tax d. all of the above

12. Which of the following is correct? A regressive tax: a. takes a larger amount of tax dollars from low income people than high income people b. takes a larger percentage of income from low income people than from high income people. c. takes a larger percentage of income from high income people than from low income people. d. takes the same percentage of income from high income people than from low income people.

13. Who will generally bear the burden of an excise tax? a. consumers only b. suppliers only c. both consumers and suppliers d. the government

14. Which causes greater expansion of the economy? a. an increase in taxes only b. an increase in government spending financed by an increase in taxes c. an increase in government spending financed by government borrowing d. the impact of all of these is equal

15. Increased government spending financed by government borrowing will generally cause: a. an increase in interest rates. b. an expansion of the economy. c. some crowding out. d. all of the above

16. A property tax on rental housing will generally cause: a. an increase in rent. b. an increase in the quantity of rental housing. c. an increase in profits to rental property owners. d. all of the above.

17. An increase in the demand for loanable funds will generally cause: a. an increase in the interest rate. b. an increase in the quantity demand of loanable funds. c. an increase in the quantity supplied of loanable funds. d. all of the above.

18. Government tax revenue of $100 billion and government spending of $80 billion in any given year results in: a. a budget deficit of $20 billion. b. a budget surplus of $20 billion. c. a national debt of $20 billion. d. a national surplus of $20 billion.

19. The largest share of the national debt is owned (owed to): a. the U.S. government and federal reserve banks. b. insurance companies c. individual owners of U.S. savings bonds. d. foreigners.

20. Which of the following can be caused by government borrowing? a. increased interest rates b. inappropriate income redistribution c. a transfer of interest payments outside of the U.S. d. all of the above

21. The difference between federal government spending and federal government tax revenue in a particular year is: a. the budget deficit. a. the national debt. b. crowding out. c. the trade deficit.

1. Economists generally believe that a law or constitutional amendment requiring a balanced budget would: a. be extremely difficult to implement. b. limit the government’s use of fiscal policy. c. destabilize the economy. d. all of the above.

True-and-False Questions

T 1. The government borrows money when it issues government securities.

T 2. The standard deduction is a fixed amount of income that taxpayers can deduct from their taxable income when calculating their personal income taxes, if other deductions are not claimed.

T 3. A tax credit directly reduces the amount of tax payable to the government.

F 4. A refundable tax credit means that it is available only if the person pays income taxes.

T 5. A payroll tax is deducted directly from the worker’s paycheck.

T 6. Excise taxes bring in about 4% of federal tax revenue.

F 7. Corporate income taxes bring in about 50% of federal tax revenue.

F 8. Sales and excise taxes bring in about 80% of state and local tax revenue.

T 9. Property taxes bring in the largest share of total state and local government tax revenue.

T 10. A reduction in personal income taxes will generally result in increased consumption purchases.

F 11. Increased government spending financed by increased taxes creates greater expansion of the economy than if the increased government spending is financed by government borrowing.

T 12. It is probably better to finance government purchases by taxes when the economy is operating at full employment.

T 13. A regressive tax is one that takes a larger percentage of income from low-income people than from high-income people.

F 14. Property taxes are generally considered to be progressive.

T 15. The effect of President G. W. Bush’s federal personal income tax cut would be to reduce the progressivity of the U.S. tax system.

T 16. An excise tax generally results in a higher price of the product, though the price usually does not increase by the full amount of the excise tax.

F 17. Increased government borrowing will generally cause a decrease in interest rates.

T 18. Crowding out refers to a situation whereby increased government borrowing results in increased interest rates, thereby causing some reduction in private borrowing.
F 19. Only about 5% of the national debt is owned by (owed to) various levels and agencies of government.

T 20. Government borrowing has the positive consequences of enabling the government to expand the economy as needed and to make expenditures that can benefit our society.

T 21. The total amount of money that the government has ever borrowed and not yet repaid is the national debt.

F 22. Property taxes are used primarily to finance local public prisons.

F 23. The national debt will eventually bankrupt the nation.

Short -Answer Questions

1. Show in the graphs the effects of the following on GDP:

a. Increased government spending on highway construction financed by government borrowing.

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b. Increased government spending on highway construction financed by increased taxes.

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c. Which situation results in a larger increase in GDP, assuming the increase in government spending is the same in each case? ____________

2. Calculate the effects of a sales tax on a hypothetical higher and lower income family, by calculating the values for the bottom two rows of the following table. (Answers are shown in parentheses.)

Higher Lower Income Family Income Family

Income $200,000 $50,000

Purchases of taxable $100,000 $45,000 goods and services

Sales tax rate 10% 10%

Amount of sales ($10,000) ($4,500) tax paid

Amount of sales tax (5%) (9%) paid as a % of income

3. Consider the hypothetical market for alcohol. Draw the shift that will occur with the imposition of an excise tax. What is the effect on the price paid by consumers? ____________ What is the effect on the quantity of alcohol bought and sold? ____________ Who bears the burden of the excise tax? ____________________________________ (Extra from the appendix: who bears the burden of the tax if the demand for alcohol is perfectly inelastic? ____________ )

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