Question

Answer whether or note the following statements are true, false or uncertain. Justify your answers.

1. A country that has constant output expects a large temporary increase in government expenditures sometime in the future due to an infrastructure project. Optimal taxation implies that the level of the overall tax rate in the years before the project begins is higher than its level after the project. (Assume that the government is collecting its revenue through proportional taxes and that output always remains constant.)

2. Increasing the income tax rate for the rich will always improve social welfare.

Answer 1

1. False. This is because theoretically, it is not possible for any govt. to reduce its tax rates once it has increased. This is because once the govt. has increased taxes, the people get accustomed to paying more taxes and also become habitual to higher spending by the govt. Thus, it is a political suicide for any govt. to reduce the tax rate and thereby reduce the level of welfare to the general public.

2. False. Increasing the income tax rate for the rich will not always improve social welfare. This is because very high tax rates might even induce the people to not pay taxes and the effective earning of the govt. will thus fall down.