SCENARIO INTRODUCTION
Use the information provided below to complete the questions.
Suppose a small economy has two income tax rates: 15% for all income up to $50,000 and 30% for any income earned above $50,000. Suppose that the economy has a Government Budget for this year (year 1) of $58,500, and a total of five individuals earning the following income: Amy $20,000, Betty $40,000, Charlie $60,000, Dimitry $80,000, Evelyn $100,000. In chapter 5 we saw that GDP can be calculated in two ways, via the expenditure approach or the income approach, and that when the income approach is used, there must be adjustments made to National Income, specifically adding the Consumption of Fixed Capital and a Statistical Discrepancy. For the sake of simplicity, let’s imagine that National Income is equal to GDP, in other words the Fixed Capital and the Statistical Discrepancy are equal to zero.
CALCULATING TAX REVENUES – YEAR 1
1. Calculate the Total Tax Revenues. a) what would be the total tax revenue paid by each of the five citizens? b) what is the total tax revenue for the small nation?
2. What is the small Nation’s Income in year 1?
3. What percent of the Nation’s Income does the Total Tax Revenue represent?
4. In year 1, does the economy have a balanced budget, a budget surplus, or a budget deficit. Accompany your response with the corresponding dollar amount.
5. Now assume that a recession causes each of the five incomes to fall by 25%. In other words, income is 75% of what they used to be. Given the lower income,
a) what would be the total tax revenue paid by each of the five citizens?
b) what is the total tax revenue for the small nation?
6. What is the Nation’s Income in year 2?
7. In year 2, what percent of the Nation’s Income does the Total Tax Revenue represent?
8. Suppose that the Government Budget remained the same in year 2. Is the economy experiencing a balanced budget, a budget surplus, or a budget deficit, in year 2? Accompany your response with the corresponding dollar amount.
9. Using the answers for part 1 and part 2. Explain how this progressive tax structure acts as an automatic stabilizer.
10. Using the answers for part 1 and part 2. What is the size of the recessionary Gap? In other words, what is the dollar value of the GDP that is being lost (not produced) because of the recession?
11. Assuming a Marginal Propensity to Save of 20% or 0.20, use the Keynesian Multiplier to determine the additional amount of government spending required.
