Question

Imagine a taxation system where marginal tax rates at the bottom of the income distribution are equal to 1 and decreasing with income (i.e. the more the income, the less the marginal tax rate).

(a) Could this system be efficient? If yes/no, why?

(b) Could it be fair to the low earners? Under what conditions?

Answer 1

The marginal tax rate is the tax rate paid on the additional dollar of income. If the marginal tax rate equals 1 and is decreasing with income, such a system is known as a regressive tax rate system.

Based on the ability-to-pay principle, the rich should pay a higher tax and marginal tax rates should increase. The strongest argument for why the rich should pay more is that the marginal utility of their money has much less value for them than it does for the working class. Therefore, this system cannot be efficient.

This system is not fair to low earners because by charging them the same as high earners it is reducing their purchasing power significantly more than the high earners.