Question

The city of Johnstown decides to build a new stadium to attract a basketball team from the city of Rosendale. One economic advisor suggests that the stadium should be financed by a 2-year sales tax of 10%, while another advisor suggests that the stadium should be financed with a 20-year sales tax of 1%. Assume the interest rate is zero. Which approach will yield a more efficient outcome? Why?

Answer 1

Answer:

A 20-year sales tax of 1% will be more efficient.

Explanation:

The reason is that the major component of goods that are usually affected by general sales are elastic goods, and therefore a 10% sales tax for 2 years will increase price of the goods and then have a negative effect on the quantity demanded.

A 10% sales tax will also negatively affect the stadium financing within the expected 2 years as it will result in a dead weight loss in the economy.

Since the interest rate is zero, this indicates that the economy will not incur any loss by paying back the debt over longer time of 20 years. Therefore, a 20-year sales tax of 1% will be more efficient.