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Exam 1: An Introduction to Tax

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Question 1

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Given the following tax structure, what is the minimum tax that would need to be assessed on Dora to make the tax progressive with respect to average tax rates? What is the minimum tax that would need to be assessed on Dora to make the tax progressive with respect to effective tax rates?

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Diego's average tax rate is 5 percent.
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Question 2

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Bart is contemplating starting his own business. His new business would operate as a sole proprietorship and would require hiring several employees. Describe the employment-related taxes that Bart should be aware of as he starts his new business as a self-employed business owner.

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Employment taxes consist of the Old Age, Survivors, and Disability Insurance (OASDI)tax, commonly called Social Security tax, and the Medical Health Insurance (MHI)tax, known as the Medicare tax. The Social Security tax pays the monthly retirement, survivor, and disability benefits for qualifying individuals, whereas the Medicare tax pays for medical insurance for individuals who are elderly or disabled. The tax base for the Social Security and Medicare taxes is wages or salary, and the rates are 12.4 percent and 2.9 percent, respectively. Employers and employees split this tax equally. Thus, Bart will have to pay the employer's portion of these taxes for his employees. As a self-employed individual, Bart must also pay the self-employment tax, which is basically the same as the employer's and employee's share of the Social Security and Medicare taxes. The tax rates for these taxes are 12.4 percent and 2.9 percent, respectively, and the tax base is net self-employment income. The self-employment tax is in addition to any federal income tax owed by the individual. In addition to the Social Security and Medicare taxes, employers are also required to pay federal and state unemployment taxes, which fund temporary unemployment benefits for individuals terminated from their jobs without cause. The tax base for the unemployment taxes is also wages or salary.

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The largest federal tax, in terms of revenue collected, is the Social Security tax.

Ricky and Lucy are debating several types of taxes. Their debate has focused on the different types of tax rate structures and whether they are "fair." Please define each tax rate structure, provide examples of each structure, and discuss how each structure may be viewed with respect to vertical equity.

Which of the following is not one of the basic tax rate structures?

Curtis invests $250,000 in a city of Athens bond that pays 7 percent interest. Alternatively, Curtis could have invested the $250,000 in a bond recently issued by Initech, Inc. that pays 9 percent interest with similar risk as the city of Athens bond. Assume that Curtis's marginal tax rate is 24 percent. How much explicit tax would Curtis incur on interest earned on the Initech, Inc. bond?

Milton and Rocco are having a heated debate regarding a national sales tax. Milton argues that a national sales tax is a proportional, vertically equitable tax. Rocco argues that a national sales tax would be a regressive, vertically inequitable tax. Explain both sides of the argument.

Mandy, the mayor of Bogart and a strong advocate of a clean downtown, is proposing an increase in the city sales tax from 7 percent to 50 percent on all packs of chewing gum purchased in Bogart. Based on the current gum sales, Mandy estimates that this tax will actually reduce the tax revenue on gum sales. What type of forecasting is Mandy using to derive her tax revenue estimates? What "effect" is her estimate based on? Does this necessarily imply that Mandy will be happy given her desire to have a clean downtown?

A 1 percent charge imposed by a local government on football tickets sold is not considered a tax if all proceeds are earmarked to fund local schools.

The estate tax is assessed based on the fair market values of transfers made during a taxpayer's life.

Margaret recently received a parking ticket. This is a common example of a local tax.

Which of the following would not be a failure of the horizontal equity concept?

Curtis invests $250,000 in a city of Athens bond that pays 7 percent interest. Alternatively, Curtis could have invested the $250,000 in a bond recently issued by Initech, Inc. that pays 9 percent interest with similar risk as the city of Athens bond. Assume that Curtis's marginal tax rate is 24 percent. If Curtis invested in the Initech, Inc. bonds, what would be his after-tax rate of return from this investment?

Congress recently approved a new, smaller budget for the IRS. What taxation concept evaluates the cost of administering our tax law?

Implicit taxes are indirect taxes on tax-favored assets.

Given the following tax structure, what amount of tax would need to be assessed on Carrie to make the tax horizontally equitable? What is the minimum tax that Simon should pay to make the tax structure vertically equitable based on Fantasia's tax rate? This would result in what type of tax rate structure?

Dynamic forecasting does not take into consideration taxpayers' responses to a tax change when estimating tax revenues.

One must consider the "economy" criterion in evaluating tax systems from both the taxpayer's and the government's perspective.

Tax policy rarely plays an important part in presidential campaigns.

The two components of the tax calculation are the tax rate and the taxpayer's status.