1. Compare a tax deduction to a tax credit. Which is more vertically equitable?
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Question
1. Compare a tax deduction to a tax credit. Which is more vertically equitable? Why? Or show why a tax deduction reduces taxes more for persons in higher income brackets.
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2. In Tax by Design, James Mirrlees and his collaborators make the following statement: The fiscal system (tax and expenditures) can be progressive even when each tax is not progressive. In fact, most of the progressivity in a fiscal system comes from the expenditure side of the budget and to a lesser extent from the tax side. Explain what they mean in the context of what you know about tax burdens and expenditures in the United States.
Explanation / Answer
If we compare the tax credit and tax deduction then we can see that if there is a deduction of $1, it will reduce the total tax liability by less than $1 i.e. the marginal tax rate on the other hand $1tax credit reduces the tax liability by $1. If we look at this from the perspective of tax liability, a credit is far better than the tax deduction. None of the systems are completely horizontal as there is no dependency of deduction and credits on the income
The deduction reduces the tax liability of a person by the amount of the deduction times the marginal tax rate of the filer and therefore it will worth more to the taxpayers who are in higher income tax brackets. Let us consider that $10000 deduction will decrease the taxes by $1500 per individual in the 15% tax bracket on the other hand, the similar type of tax deduction cut taxes by $3500 for the individual who fall in the bracket of 35%. Thus a tax deduction reduces taxes more for persons in higher income brackets
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