Question

Song earns $100,000 taxable income as an interior designer and is taxed at an average rate of 20 percent (i.e., $20,000 of tax). Answer the questions below assuming that Congress increases the income tax rate such that Song's average tax rate increases from 20 percent to 25 percent. a. What will happen to the government’s tax revenues if Song chooses to spend more time pursuing her other passions besides work in response to the tax rate change and therefore earns only $75,000 in taxable income? multiple choice 1 Government's tax revenues would decrease by $1,250 Government's tax revenues would increase by $1,250 Government's tax revenues would decrease by $1,500 Government's tax revenues would increase by $1,500 Government's tax revenues would remain unchanged b. What is the term that describes this type of reaction to a tax rate increase? multiple choice 2 Budget constraint Substitution effect Endowment effect Price effect Income effect c. What types of taxpayers are likely to respond in this manner? multiple choice 3 Taxpayers with less disposable income Taxpayers with more disposable income

Answer 1

a. If Song earns only $75,000 in taxable income, the government's tax revenues will be $18,750 ($75,000 x 25%) and a. Government's tax revenues would decrease by $1,250.

b. The term that describes this type of reaction to a tax rate increase is d. Income effect.

c. The taxpayers that will likely respond in this manner are b. Taxpayers with more disposable income.

Data and Calculations:

Song's taxable income per year = $100,000

Average tax rate = 20%

Tax liability per year = $20,000 ($100,000 x 20%)

New Tax Regime:

Tax rate = 25%

New taxable income of Song = $75,000

Tax liability = $18,750 ($75,000 x 25%)

Thus, if the tax rate is increased from 20% to 25% forcing Song to reduce his taxable income to $75,000,  a. Government's tax revenues would decrease by $1,250.

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