QUESTION FOUR a) You are a consultant to the government of Kabalika. The governm

Question

QUESTION FOUR a) You are a consultant to the government of Kabalika. The government has decide to cut taxes on apples, bananas, and yogurt, and it wants your input on which fruit would be the best choice for a tax cut. It provides you with the following information. What is your recommendation, and why? 10 MARKS) Unit Sales Price (thousands) Marginal deadweight loss Good Marginal tax Unit tax revenue (thousands of (thousands of dollars per $1 dollars per $1 additional tax) additional tax) Apples $1 100 Bananas $2 Yogurt $0.10 20 $0.25 30 $0.15 10 5 100 50 20 $4 20 b) Luxury goods often have much higher elasticities of demand than do goods purchased by a broad base of people. Why, then, are governments more likely to (5 MARKS) ) Discuss the Haig-Simons and Musgrave view of an idea tax base. What are the (10 MARKS) tax luxuries than these 'staple" goods? equity implications of each view? TOTAL: 25 MARKS]

Explanation / Answer

Answer:- The axes must be decided in such a manner so that the marginal deadweight burden per marginal dollar of revenue generated should be equal for all the goods.

the marginal deadweight burden per marginal dollar of revenue of these fruits are:-

Apple=5/20=0.25

Banana=20/30=0.67

Yogurt   =20/10 = 2

As the marginal deadweight burden per marginal dollar of revenue is maximum for Yogurt, thus it should be having tax reduction.

Answer:- While the Ramsey Rule would suggest taxing goods that are inelastic demanded, thus minimizing deadweight loss, there are other factors to consider; in particular, equity concerns are often inconsistent with this implication of optimal taxation.

A tax on inelastic demanded staples such as food would be regressive. Poorer people would spend a higher proportion of their income on necessities, so they would bear a disproportional share of a tax on those items.

Wealthy people are much more likely to purchase luxury items, so the direct effects of a tax on these goods would be progressive.

Indirect effects, like employment in the sectors that produce and service luxury goods, might have implications for equity and effi­ciency

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