Questions and Problems for Discussion

Chapter 02 - Policy Standards for a Good Tax Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.2-1 Chapter 2 Policy Standards for a Good Tax Questions and Problems for Discussion

• This question is designed to lead to a class discussion of the various tax policy issues

introduced in Chapter 2.

• Historically, the federal income tax system has not generated enough revenue to fund the

government’s spending programs. Consequently, the federal government has borrowed money to make up its deficits (excess of spending over revenues) and in doing so has amassed an $11 trillion national debt. The federal government operated at a deficit in every year from 1970 through 1998. In 1999 and 2000, it operated at a small surplus (excess of revenues over spending), but reverted to massive deficit spending in 2001 and subsequent years.

• Governments can impose a new tax (by identifying and taxing a new base), increase the rate of

an existing tax, or expand the base of an existing tax.

• Governments that fail to control the growth of their money supply run the risk of devaluing the

currency and triggering a crippling rate of inflation. Therefore, simply printing more money to fund an operating deficit is not a viable, long-term solution to an insufficient tax system.

• Mrs. E could enter the work force. Her after-tax earnings could offset the decrease in the

couple’s disposable income attributable to the tax rate increase. If Mr. E works for an hourly wage, he could possibly work more hours for his employer. If he doesn’t have this option, he could take a second job or even start a new business.

• As a self-employed individual, Mrs. F may have the flexibility to increase the number of

hours devoted to her business. Her additional after-tax earnings could offset the decrease in the couple’s disposable income attributable to the tax rate increase. Mr. F has the same options as Mr. E.

• In this case, Mr. and Mrs. G have the same options as Mr. E and Mr. F. Because they are

both full-time employees, their ability to increase their before-tax income may be limited.

• Mr. H may not have any realistic way to decrease the time spent at work and increase his

leisure time, even if the after-tax value of his labor decreases because of a tax rate increase.Mrs. H’s behavior should not change because of a tax rate increase.

• Mrs. J could quit her job and leave the work force if the couple decides that her leisure time

is worth more than the after-tax value of her labor.

• As a self-employed individual, Ms. K has the flexibility to decrease the number of hours

devoted to her business, thereby substituting additional leisure time for labor.

• An increase in the income tax rate decreases the after-tax value of the bond investment but

does not affect the value of the luxury auto. (Her personal use and enjoyment of the auto are nontaxable benefits to Ms. V.) Consequently, she may decide to consume the $40,000 (i.e., buy the auto) rather than to save it.

• People derive many psychological benefits from working: a sense of self-worth and self-reliance,

prestige and status, intellectual challenge, a social network, and a belief that their work makes the world a better place. These forms of psychic income may be as important (or even more important) than monetary incentives.Principles of Taxation for Business and Investment Planning 21st Edition Jones Solutions Manual Visit TestBankDeal.com to get complete for all chapters

Chapter 02 - Policy Standards for a Good Tax Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.2-2

• A national sales tax might reduce the aggregate level of consumer demand for taxable goods

and services. In this case, the tax base would decrease and state and local sales tax revenues would decline.

• Arguably, the estate tax is more convenient for two reasons. First, individuals with accumulated

wealth can’t avoid the tax indefinitely. Second, a person’s death is a matter of public record so that the IRS can easily determine when a potentially taxable event (the transfer of wealth at death) has occurred.

• Market economies (and the firms operating in those economies) adapt to the various taxes

imposed on business transactions. The longer a tax (or a specific tax rule) has been in effect, the better the business community understands it. When governments change the tax system, the business community must spend time and money studying and reacting to the change. Firm managers must reassess, or even modify, their tax strategies. Thus, any change in the tax environment is both costly and unsettling, even if the purpose of the change is to improve the environment.

• Clearly, the system in which employers must withhold and remit income tax from their

employees’ paychecks is more convenient for the government because the collection process is greatly concentrated. The withholding system is more convenient for individual employees who are not required to compute their monthly tax bills or mail tax payments to the government.Instead, their employers perform these tasks on the individuals’ behalf. The withholding system shifts much of the cost of compliance to employers and is, therefore, more inconvenient from the employers’ perspective.

• a. This provision clearly is intended to encourage and reward a certain economic behavior (the

purchase and use of snow removal equipment by private firms) and, therefore, meets the definition of a tax preference.

• Jurisdiction E is assuming that it can reduce its snow removal costs by $550,000 because

more firms will own the equipment to perform this function for themselves.

• For the income tax system to be equitable, the tax base (taxable income) should be defined as

precisely as possible to reflect each individual’s economic ability to pay. However, the greater the number of personal and financial circumstances taken into account in defining taxable income, the greater the complexity of the law.

• a. This is a progressive rate structure with a -0- rate on income up to $35,000 and a 15 percent

rate on income in excess of $35,000.

• This is a proportionate rate structure.
• This is a regressive rate structure with a 15 percent rate on income up to $80,000 and a -0-

percent rate on income in excess of $80,000.

16. Jurisdiction Q could enact:

A gross receipts tax. Because Corporation R and Corporation T both have $5 million gross receipts, they would pay the same tax. Corporation T could argue that this result is horizontally inequitable because its gross and net profit are less than Corporation R’s gross and net profit, indicating that Corporation T has less ability to pay a tax.A tax based on gross profit. Because Corporation R has more gross profit than Corporation T, Corporation R would pay the greater tax. Corporation R could argue that this result is horizontally inequitable because it has a higher ratio of annual operating expenses to gross profit (55.5 percent) than Corporation T (30.1 percent). Consequently, gross profit doesn’t accurately reflect the two corporations’ ability to pay tax.

Chapter 02 - Policy Standards for a Good Tax Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.2-3 A tax based on net profit before charitable contributions. In this case, Corporation R’s tax base would be $800,000, and Corporation T’s tax base would be $930,000. Corporation T might argue that its generous charitable contributions reduced its economic ability to pay and should be taken into account. Corporation R could refute by arguing that discretionary charitable contributions are irrelevant to the measurement of ability to pay tax on business earnings.A tax based on net profit after charitable contributions. In this case, Corporation R would pay more tax than Corporation T and could argue that allowing Corporation T to deduct charitable contributions violates the concept of horizontal equity.

• Ms. P should consider her marginal rate: the rate at which the incremental income from the

investment will be taxed. For tax planning purposes, the average tax rate that she pays on her entire income is irrelevant.Application Problems

• Next year’s excise tax revenue will be $880,000 ($8 million base × 11%).
• Next year’s excise tax revenue will be $1,023,000 ($9.3 million base × 11%).
• Next year’s excise tax revenue will be $770,000 ($7 million base × 11%).
• Next year’s restaurant tax revenue will be $441,000 ($29.4 million base × 1.5%).
• Next year’s restaurant tax revenue will be $540,000 ($36 million base × 1.5%).
• Next year’s restaurant tax revenue will be $615,000 ($41 million base × 1.5%).
• Next year’s hotel tax revenue will be $1.5 million ($25 million base × 6%).
• Next year’s hotel tax revenue will be $1.32 million ($22 million base × 6%).
• Next year’s hotel tax revenue will be $1.14 million ($19 million base × 6%).
• Before the rate increase, Mrs. K’s disposable income is $35,700 ($42,000  $6,300 tax). If the

tax rate increases from 15 percent to 20 percent, she must earn an additional $2,625 to maintain this income. This number is derived from the following formula.($42,000 + additional income)  20% ($42,000 + additional income) = $35,700 If Mrs. K can earn an extra $2,625, her disposable income won’t be affected by the rate increase.Taxable income $44,625 Tax rate .20 Tax $8,925 After-tax income ($44,625 – $8,925) = $35,700

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• Before the rate increase, Mr. and Mrs. E’s disposable income is $66,400 ($83,000  $16,600

tax). If the tax rate increases from 20 percent to 28 percent, Mrs. E must earn an additional $9,222 to maintain this income. This number is derived from the following formula.($83,000 + additional income)  28% ($83,000 + additional income) = $66,400 If Mrs. E can earn $9,222 from her part-time job, the couple’s disposable income won’t be affected by the rate increase.Taxable income $92,222 Tax rate .28 Tax $25,822 After-tax income ($92,222 – $25,822) = $66,400

• $125,000 tax base (Mr. and Mrs. J’s taxable income)  8% rate increase = $10,000

additional revenue collected from Mr. and Mrs. J.

• $140,000 increased tax base  40% $56,000

Tax collected on original $125,000 base  32% (40,000) Additional revenue collected from Mr. and Mrs. J $16,000

• $110,000 decreased tax base  40% $44,000

Tax collected on original $125,000 base  32% (40,000) Additional revenue collected from Mr. and Mrs. J $4,000

• $300,000 tax base (Ms. BK’s taxable income)  10% rate decrease = $30,000 decrease in

revenue collected from Ms. BK.

• $375,000 increased tax base  25% $93,750

Tax collected on original $300,000 base  35% (105,000) Decrease in revenue collected from Ms. BK $(11,250)

• $275,000 decreased tax base  25% $68,750

Tax collected on original $300,000 base  35% (105,000) Decrease in revenue collected from Ms. BK $(36,250)

• Jersey Inc.’s income tax is $273,000 ($3.9 million  7%), and its average and marginal tax

rates are 7%.

• Leray Inc.’s income tax is $350,000 ($5 million  7%). Its average rate is 3.6% ($350,000 ÷

$9.6 million), and its marginal rate is 0%.

• Jurisdiction B uses a regressive rate structure because the average rate decreases as the

tax base (corporate income) increases.

• Mr. Hill’s taxable income is $63,750 ($98,750 – $35,000), and his tax is $8,925 ($63,750 ×

14%). His average rate is 9% ($8,925 ÷ $98,750), and his marginal rate is 14%.

• Ms. Lui’s taxable income is $12,900 ($47,900 – $35,000), and her tax is $1,806 ($12,900 ×

14%). Her average rate is 3.8% ($1,806 ÷ $47,900), and her marginal tax rate is 14%.c Ms. Archer’s average and marginal rates are zero.

• Jurisdiction X uses a progressive rate structure because the average rate increases as the

tax base (individual income) increases.