MGEC31H3 Study Guide - Deadweight Loss, Tax Efficiency, Intergenerational Equity

Economics for Management Studies
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1. A)
The term “Excess Burden” is the loss of welfare that is unrecoverable due to tax
spending even if the money can be given back to the payers later on. This is also called
“Dead Weight Loss”.
In the first article “Blame Taxes for Baltimore’s Rot”, the author inferred that the
“Third World Like” economic situation is majorly caused by the astonishingly high
property tax rate. As the article illustrates, the property tax increased by 21 times within
35 years in the city of Baltimore. Which leads to the massive abandon rate of houses in
the city that will cost extra tax money to demolish or renovate. One clear relationship
between property tax and economic development is that the high rocketing tax rate has
caused the unemployment to go up so that normal households’ ability of supporting
their houses was harmed. Consequently, citizens became poor and the crime rate went
up. What’s even worse is that the city government only focused on treating the
symptoms instead of the root of the problem. Even higher spending on social spendings
kept highering the tax rate so that the vicious cycle turned unstoppable. This is an
obvious example of the impact from excess burden due to high tax rate and low social
welfare return.
In the second article, the deadweight loss is shown by the undervalued gifts. It
illustrates that most of the gifts bought and given buy gift givers are undervalued for at
least 10% by the gift receivers. This finally leads to a further extra spending on same
goods and waste of resources that could be averted without making anyone worse off.
b) The term “optimal income tax” refers to a situation where both “efficiency” and
“fairness” are met so that the trade off between the two is minimized. On one side the
compliance and administrative cost is minimized and on the other side the utility is
maximized and no one is economically worse off. Also, we want the optimal tax to be
equitable tax, i.e. both equitable in horizontal and vertical, minimum tax evasion and
intergenerational equity.
In the article “Why Do Americans Work More Than Europeans?” the author pointed
out the main reason why Americans work more is that they have low tax rate but high
debt. People have to work more to pay their debt as well as helping government to
raise enough money to sustain social services. Government lower the tax rate in order
to eliminate excess burden thus the tax efficiency is at its maximum level.
Consequently, American government trades off fairness for efficiency, which is
consistent with the optimal income taxation.
In the second reading Ontarios Tax on the Rich: Grasping at Straw Men I learnt
that the society can trade off efficiency for fairness by taxing the rich. When charging
extra tax on people with higher income we lose efficiency due to larger excess burden,
however it brings a higher fairness because the poor is better off than before. So
Ontario government choose to tax rich is also consistent with the optimal income
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