This Document Contains Chapters 19 to 22 Chapter 19 The Corporation Tax Multiple Choice 1. The difference between revenues and expenditures for inputs is known as A) profits. B) debits. C) cash flow. D) net revenue. Answer: C 2. Before applying the 35 percent tax rate, firms may deduct A) employee compensation. B) interest payments. C) depreciation allowances. D) all of the above. Answer: D 3. When one company is owned by a corporation but is chartered separately from the parent company, this is A) a subsidiary. B) a clone. C) used for tax evasion. D) illegal. Answer: A 4. For corporate taxes, the lowest tax bracket is A) 9 percent. B) 12 percent. C) 15 percent. D) 22 percent. Answer: C 5. Economic depreciation is A) the change in the distribution of real income induced by a tax. B) the extent to which an asset decreases in value during a period of time. C) the money value of the net increase in an individual’s power to consume during a period. D) a subtraction from tax liability (as opposed to a subtraction from taxable income). Answer: B 6. Which one of these statements concerning the Tax Reform Act of 1986 is false? A) The Act evened out tax rates on alternative types of investment. B) The Act increased effective tax rates on equipment. C) It raised the personal exemption substantially. D) The Act had a specified time period of effectiveness. Answer: D 7. Most states do A) not collect any corporate income taxes. B) have corporate income taxes. C) not recognize entities known as corporations. D) none of the above. Answer: B 8. Investment tax credits (ITCs) are _________ the firm’s tax bill when particular capital assets are purchased. A) deducted from B) added to C) close to zero for D) none of the above for Answer: A 9. The excess burden of the corporate income tax is A) almost zero. B) greatest when the interest elasticity of saving is zero. C) a result of the combined distortion in the pattern of investment and a reduction in total investment. D) none of the above. Answer: C 10. According to research, after the Tax Reform Act of 1986, the effective marginal tax rate on equipment has A) decreased substantially. B) stayed basically the same. C) increased. D) decreased slightly. Answer: C 11. When calculating the user cost of capital, the after tax rate of return and the economic rate of depreciation interact by A) multiplication. B) subtraction. C) division. D) addition. Answer: D 12. When each stockholder incurs a tax liability on his or her share of the earnings of a corporation (whether or not the earnings are distributed), this is known as A) being fully funded. B) full integration. C) full loss offset. D) fully imputed rent. Answer: B 13. The cost that a firm incurs as a consequence of owning an asset is known as A) accelerated depreciation. B) expensing. C) user cost of capital. D) economic depreciation. Answer: C 14. Firms use the discount rate to A) compute present value. B) account for loss inventory. C) calculate profit margins. D) repatriate parent companies. Answer: A 15. U.S. multinational corporations are allowed tax _________ for taxes paid to foreign governments. A) deductions B) exemptions C) loans D) credits Answer: D 16. A plausible elasticity of investment with respect to the user cost is A) 0.52 B) 1.62 C) 0.40 D) 2.22 Answer: C True/False 17. There are circumstances under which the corporation tax is equivalent to an economic profits tax. A) True B) False C) Uncertain Answer: A 18. Full integration would lower the effective tax rate on capital and, therefore, lead to increased saving. A) True B) False C) Uncertain Answer: C 19. In the short run, a tax on economic profits can be shifted. A) True B) False C) Uncertain Answer: B 20. Stockholders have limited liability for the acts of the corporation for which they hold stock. A) True B) False C) Uncertain Answer: A 21. Interest deductibility does not provide an incentive for debt finance. A) True B) False C) Uncertain Answer: B 22. A proprietorship is one with a single owner and unlimited liability. A) True B) False C) Uncertain Answer: A 23. Cash flow is the difference between assets and revenues. A) True B) False C) Uncertain Answer: B 24. Estimates of the effect of the user cost on investment vary greatly. A) True B) False C) Uncertain Answer: A 25. For firms, dividends are not deductible. They are, however, taxed preferentially at the individual level. A) True B) False C) Uncertain Answer: A 26. Corporations, like individuals, face an alternative minimum tax (AMT). A) True B) False C) Uncertain Answer: A 27. Firms deducting the asset’s full cost at the time of acquisition from taxable income is called investment tax credit. A) True B) False C) Uncertain Answer: B 28. Profits earned by subsidiary are taxed even if it is not repatriated to the parent company as dividends because they are considered as income for the parent company. A) True B) False C) Uncertain Answer: B Essay 29. Assume that the user cost of capital (C) is simply where r is the after tax rate of return, δ is the depreciation rate, Θ is the corporate tax rate and, r is the individual tax rate. Now assume further that the after tax rate of return is 10 percent and the economic depreciation rate is 2 percent. The firm faces corporate taxes of 35 percent with an individual tax rate of 25 percent. What is the user cost of capital in this case? Answer: Solving for C yields C = (0.10 + 0.02) / (1 - 0.35) (1 - 0.25) = 0.2462 or 24.62%. 30. Return to Question 17 above. Suppose that we now know that the present value of depreciation allowances is 0.20. In addition, there is an investment tax credit of 0.10. How does this new information change your answer to Question 17? What effect does this new information have on the user cost of capital? Answer: Simply take the answer from Question 17 and multiply it by (1 – 0.20 – 0.10). In the presence of depreciation allowance and investment tax credit, the cost of capital can be calculated as: where ψ is the depreciation allowance and k is the investment tax credit. Therefore, we have 0.2462 (1 – 0.20 – 0.10) = 0.1723 or 17.23%. The user cost of capital is now lowered. 31. Oxnard Rims, Inc., has $5 million in assets and $2 million in debt. During the course of the year, it takes in $1 million in net revenue after deduction of all costs (except for interest) and incurs interest expenses of $500,000. Oxnard Rims, Inc., pays an average tax rate of 35% on its profit. Calculate the percentage return on equity after taxes for the corporation. If the market interest rate is 12.5%, do you think Oxnard Rims pleased its investor for the preceding year? Answer: (A) Oxnard has equity of $3 million (5M – 2M). After deduction of interest paid, net profit is $500,000 and the tax liability is $175,000. The net profit after taxes is $325,000. This is 10.8 % of equity. (B) No, because ROE is less than the market rate 32. Suppose you are only concerned with national income maximization. You know that the marginal rate of return on foreign investment is 8 percent, but that the tax rate on foreign investment is 2 percent. What is the minimal tax rate necessary in the United States to maximize national income? Answer: According to Equation 17.8 in your textbook, you need (1 – tf) rf = rus; therefore, (1 0.02) 0.08 = 0.0784 or 7.84%. 33. This question is similar to Question 9 of Chapter 19 in your textbook. The ABC Corporation is contemplating purchasing a new computer system that would yield a before-tax return of 30 percent. The system would depreciate at a rate of 3 percent per year. The after-tax interest rate is 11 percent, the corporation tax rate is 35 percent, and a typical shareholder of ABC has a marginal tax rate of 30 percent. Assume for simplicity that there are no depreciation allowances or investment tax credits. Do you expect ABC to buy the new computer system? Answer: Substituting into the formula, the user cost is (.11 + .03) / [(.65)*(.7)] = .307. The project’s return is lower than this, so the company does not proceed with the project. 34. Large firms sometimes have manufacturing and development that take place in multiple states. Should they be subject to taxation in every state in which they do business? Answer: Generally, the answer here is yes, since state resources and infrastructure were used in the manufacturing and development process. As the textbook points out, however, these matters are complicated by factors such as tax exporting and interstate mobility of factors. 35. Your textbook highlights a debate that has been going on for some years. The issue is whether there should be a corporation tax, given that corporations are nothing more than groups of people. Should there be a corporation tax? Why or why not? Answer: The debate will be answered by investigation whether a switch in taxing systems will generate the same level of tax revenue without causing harm to the economy. Theoretical models have yielded mixed results as to the effectiveness of a switch. It will have to be tested empirically to know for sure. 36. Why do firms pay dividends? It would appear that they are subject to double taxation, giving more incentive to eliminate them. Answer: Dividends may serve as a signal of a firm’s financial strength. They may also be used to cater to a particular clientele. Chapter 20 Deficit Finance Multiple Choice 1. When a model takes into account the fact that several different generations may coexist simultaneously, this is known as a(n) A) neoclassical model. B) life-cycle model. C) overlapping generation model. D) crowding out model. Answer: C 2. In 2008, the amount of the debt held by the public as a percent of GDP was A) 33.3. B) 59.3. C) 41.0. D) 20.3. Answer: C 3. Because of the differing account conventions, there is a great deal of arbitrariness in a number that purports to be A) the deficit. B) the surplus. C) the debt. D) all of the above. Answer: D 4. During the period from 1999 - 2008, federal budget deficits A) were never calculated. B) fell dramatically. C) increased as a percentage of GDP. D) can be regarded as structural. Answer: C 5. The purpose of functional finance is to A) decrease deficits through monetary policy. B) use fiscal policy to keep aggregate demand at the desired level, regardless of the impact on deficits. C) tax corporate income first at the corporate level, and then again when it is distributed to shareholders. D) use monetary policy to keep deficits stable over time. Answer: B 6. High real interest rates A) increase the demand for the domestic currency by foreigners. B) cause decreased job opportunity. C) cause worker productivity to decrease. D) crowd out interest-sensitive expenditures. Answer: A 7. When government borrowing decreases private investment by raising the market interest rate, this is known as A) the Director’s Law. B) crowding out. C) positive economics. D) the Ramsey Rule. Answer: B 8. At a given point in time, if all past deficits and surpluses were added, we would get the A) Ricardian model. B) debt. C) crowding out model. D) total amount of excess burden. Answer: B 9. When the government borrows in the market, it A) does not have to pay interest. B) is not required to pay back the entire principle. C) can get indefinite extensions on the loan. D) does all of the above. E) does none of the above. Answer: E 10. Inflation A) increases the real value of the debt. B) has no impact on the debt. C) decreases the real value of the debt. D) is always factored into any calculations of deficits or surpluses. Answer: C 11. The portion of a government's indebtedness owed to foreigners is A) external debt. B) internal debt. C) not recoverable. D) net debt. Answer: A 12. Which one of the following statements is true? A) A budget surplus will reduce national saving. B) A budget deficit decreases national saving. C) A budget deficit will decrease interest rates. D) A budget deficit increases national savings. Answer: B 13. According to a model of intergenerational equity, if future generations are expected to be better off than the current generation, transfers should A) go from the richer generation to the poorer generation. B) not be done at all. C) go from the poorer generation to the richer generation. D) be weighted by increases in the inflation rate. Answer: A 14. According to the Ricardian view of government deficits, A) any future burden of tax financing should be ignored. B) government deficits reduce interest rates. C) taxpayers are less capable of saving when debt finance is used rather than tax finance. D) the private sector supply of loanable funds will increase in the face of government deficits. Answer: D 15. The burden of the debt can be viewed as A) a moral question. B) a political question. C) a financial question. D) all of the above. Answer: D 16. Lerner’s view on debt financing is A) Future generations bear a burden of external debt. B) Burden of debt can be transferred across generations. C) Internal debt creates no burden for the future generations. D) Government debt crowds-out the available funds for private sector. Answer: C True/False 17. The burden of the debt does not depend on whether debt finance crowds out private investment. A) True B) False C) Uncertain Answer: B 18. The level of economic activity in a given year will cause the budget deficit to vary. A) True B) False C) Uncertain Answer: A 19. The burden of debt is borne by future generations. A) True B) False C) Uncertain Answer: C 20. The United States has not had a surplus in the last 30 years. A) True B) False C) Uncertain Answer: B 21. Before World War II, the United States did not use deficit financing and paid for all goods and services with cash. A) True B) False C) Uncertain Answer: B 22. High interest rates contribute to a lower federal budget deficit. A) True B) False C) Uncertain Answer: B 23. From an efficiency standpoint, one must compare the excess burdens of tax and debt finance. A) True B) False C) Uncertain Answer: A 24. Surpluses will help future generations more than deficits will hurt future generations due to inflation and taxes. A) True B) False C) Uncertain Answer: C 25. The deficits of the 1980s can be regarded as structural. A) True B) False C) Uncertain Answer: A 26. In the year 2008, nearly half of all privately held federal debt was held by foreign investors. A) True B) False C) Uncertain Answer: B 27. Total Government Debt is the sum of previous surplus and deficits. A) True B) False. C) Uncertain Answer: A 28. Ricardian view on debt is that the form of government finance is irrelevant A) True B) False C) Uncertain Answer: A Essay 29. Refer to Figure 20.3 in your textbook. Suppose the equation that equates excess burden to the tax rate can be written as EB = t2, where EB is excess burden and t is the tax rate. (A) Suppose the tax rate t is initially 12 percent. How much excess burden is generated? (B) If the tax rate doubles to 24 percent, what happens to excess burden? Answer: (A) When the tax rate is 12 percent, EB is 0.122 = 0.0144. (B) When the tax rate doubles, EB is 0.242 = 0.0576, which is more than double. 30. Suppose, in 2008, the federal debt was $5 trillion. That year, the United States ran a deficit of $455 billion. During the course of the year, the inflation rate was 3.8%. How much is the “inflation tax”? Answer: In order to calculate the “Inflation tax, multiply the federal debt by the inflation rate ($5 trillion x 0.038) = $190 billion = Inflation Tax. Effectively, the federal deficit is reduced to $455 billion – $190 billion = $365 billion. 31. You make a loan to the government of $100. The government promises to pay you back some sum of money in two years. The interest rate will be 4 percent over that period, but inflation will be 4 percent. How much will you require that the government pay you in two years in the absence of any inflation? With inflation? Answer: You could have saved the $100 dollars for two years, had X = 100 (1.04)2 = $108.16, but the purchasing power of your money would have been decreased by inflation. So, to counter those effects, you would ask for X = 100 (1.08)2 = $116.64. 32. If raising taxes or borrowing are your only two choices of financing current expenditures, which would you choose, and why, if you were in charge of setting policy? Answer: Both systems have drawbacks. Increasing taxes might limit economic growth by reducing consumer spending. Borrowing could cause crowding out by the private sector. The question can be answered by examining which system will create the most economic good, while causing the least amount of economic harm. A third alternative is to reduce current expenditures so that there is no need for deficit financing. This view is normally not very politically popular. 33. We have learned from this chapter that the real value of the debt is eroded by inflation and may be overestimated because of it and other factors. Do you feel that the debt will be a major concern during your working lifetime and retirement? Answer: Although answers will vary, the debt will be an area for concern. The most troublesome portion will be the increasing share of debt held by foreign investors. Other obligations, such as Medicare and Social Security, will have a greater impact. Yes, national debt is likely to remain a significant concern throughout my working lifetime and retirement due to factors like inflation eroding its real value, fluctuating interest rates impacting debt servicing costs, economic growth affecting government revenues, demographic changes straining budgets, and the importance of effective fiscal policies in managing debt levels. These factors highlight the ongoing importance of understanding and addressing national debt for economic stability and personal financial planning. 34. If we assume that government borrowing crowds out private investment, then future generations will have a smaller capital stock. Ricardo’s view is that this will not be the case, because people are forward looking. Do you agree? Answer: There is evidence that says that this is partially true, by not totally proven. People that are able to do so will leave bequests to their children. The bigger question involves those who are not able to give. Who in the future will be responsible for them? Chapter 21 Fundamental Tax Reform: Taxes on Consumption and Wealth Multiple Choice 1. A tax levied on an individual’s total lifetime acquisitions from inheritances and gifts is known as A) inheritance tax. B) death tax. C) accessions tax. D) unified transfer tax. Answer: C 2. Why might an individual set up trusts? A) as a strategy to avoid taxes on wealth. B) for lower insurance premiums. C) to insure the security of a loan. D) to have a steady stream of income during retirement. Answer: A 3. A tax, in which amounts transferred as gifts and bequests are jointly taken into account, is known as A) inheritance tax. B) death tax. C) accessions tax. D) unified transfer tax. Answer: D 4. The largest source of tax revenues for states is A) general sales. B) motor fuel. C) alcoholic beverages. D) tobacco. Answer: A 5. The Value Added Tax (VAT) is A) not often used in the United States. B) a percentage tax. C) added at each stage to production. D) all of the above. Answer: D 6. A unit tax is A) levied at different rates on the purchase of different commodities. B) less than 0. C) a percentage of the value of the purchase. D) a given amount for each unit purchased. Answer: D 7. Which of the following is a unit excise tax? A) a tax of 15% B) an admission fee of $2.00 on each ticket purchased C) an ad valorem tax of $3.00 D) an income tax of $3.00 Answer: B 8. President Obama has proposed making the _____ estate tax rate permanent. A) 13.0% B) 45.0% C) 51.3% D) 55.0% Answer: B 9. Consumption taxes are generally viewed as A) regressive. B) progressive. C) simple to calculate. D) multiplicative. Answer: A 10. A tax on consumption for those who are nonsavers A) is equivalent to a tax on income. B) causes income gains to increase dramatically. C) would be preferred to a tax on wealth. D) makes it difficult to tell what the result for the nonsavers would be. Answer: A 11. Who pays a consumption tax? A) people who purchase goods B) firms who purchase goods C) the elderly when they purchase goods D) all of the above Answer: D 12. Disadvantages of a consumption tax are A) the administrative problems. B) the transitional problems. C) dealing with gifts and bequests. D) all of the above. Answer: D 13. The gross estate is A) very disgusting. B) all property owned by decedent at time of death. C) general property that is held in a trust. D) being phased out of current tax law. Answer: B 14. Optimal commodity taxation would A) put a tax on leisure time, which is currently untaxed. B) have the smallest amount of excess burden possible for a given amount of tax revenue. C) optimize tax rates on the wealthiest Americans. D) eliminate tax evasion in the United States. Answer: B 15. Sale taxes are A) easy to administer at lower rates. B) correctives for externalities. C) substitutes for user fees. D) all of the above. Answer: D 16. When each firm is liable for taxes on total sales but can claim the taxes already paid by suppliers as a credit against liability we are using the A) reserve method. B) chain method. C) invoice method. D) VAT method. Answer: C 17. A wealth tax can be justified because it A) helps to correct certain (inevitable) problems that arise in the administration of an income tax. B) the higher an individual’s wealth, the greater his or her ability to pay, other things- including income – being the same. C) reduces the concentration of wealth, which is desirable socially and politically. D) are payments for benefits that wealth holders receive from government. E) all of the above. Answer: E 18. A trust that is the legal owner of a life insurance policy is A) a policy holder. B) an insurance trust. C) a trust fund. D) none of the above. Answer: B True/False 19. Wealth taxes are assessed on a stock of assets instead of a flow such as income or sales. A) True B) False C) Uncertain Answer: A 20. Excise taxes are distortionary taxes. A) True B) False C) Uncertain Answer: A 21. In the next three years, the federal tax system could be replaced with a national retail sales tax. A) True B) False C) Uncertain Answer: C 22. Value-added taxes (VAT) are very popular in the United States. A) True B) False C) Uncertain Answer: B 23. A consumption tax generally will be borne according to labor earnings. A) True B) False C) Uncertain Answer: A 24. Sales taxes are generally progressive. A) True B) False C) Uncertain Answer: B 25. One advantage of a consumption tax is that there are fewer problems with inflation. A) True B) False C) Uncertain Answer: A 26. The general tax can be considered a retail sales tax. A) True B) False C) Uncertain Answer: B 27. General sales taxes totaled 226.7 billion dollars as a source of state revenue in 2008. A) True B) False C) Uncertain Answer: A 28. Under a consumption tax, only current expenditures are taxed. A) True B) False C) Uncertain Answer: A 29. A differential commodity tax is the same as an excise tax. A) True B) False C) Uncertain Answer: A 30. A gross estate is all of the taxable assets of a person at the time of death. A) True B) False C) Uncertain Answer: B Essay 31. Refer to Figure 16.1 in your textbook. Suppose that the total number of hours (T) is 720 and the wage rate is $10. Suppose further that all income is spent on consumption, so that the vertical axis is also total consumption. (A) Sketch this graph. (B) Sketch the graph if a 5% consumption tax is imposed. (C) Can you say conclusively that a consumption tax will lower hours worked? Answer: (A) and (B) (C) We cannot say, because of different preferences. 32. Assume two people, Tom and Rose, live for two periods and are taxed on consumption in both periods. In period 0, Rose has consumption of 50. In period 1, Rose has consumption of 50. Tom has consumption of 40 in period 0. Use the formula below for lifetime consumption tax liability, Ri, to find out what Tom’s period 1 consumption must be, to ensure that tax liabilities between the two are equal, if the consumption tax rate is 9% and the rate of interest is 4%, Answer: Set these equations equal for each person such that: . 0.09*(50) + [[0.09*(50)] / 1.04] = 0.09*(40) + [[0.09*( )] / 1.04] = 60.4. 33. Little Percy lives in two periods. His earnings in the present are 150; in the future he will earn 10% more than today. The interest rate is 5 percent. If his consumption today is 160, what is the most he can consume in the future? Answer: Lifetime earnings must equal lifetime consumption; therefore, 150 + (150*1.10)/1.05 = 160 + (c/1.05) = 154.5 34. A publisher sells $400,000 worth of books, magazines, and other reading materials in a given year. The publisher earns a profit of $100,000 that year. Her purchase invoices indicate that she bought $100,000 worth of glue, paper, and other materials during the year. Her labor costs were $150,000, and she purchased $45,000 of new equipment that year. Calculate her tax liability under a 12% consumption-type, value-added tax. Answer: Value added is $400,000 - $100,000 = $300,000. Because this is a consumption type tax, the $45,000 of equipment purchases is deducted from the tax base, giving taxable value added of $255,000. The tax liability is $30,600. 35. Refer to Question 22 above. Your textbook points out the importance of not deducting payments made as wages. What difference would it make in total tax revenue collected using the consumption-type VAT if this deduction were allowed at the firm level, but individuals were subject to the same tax on their wages? Answer: The change would be that now $105,000 is subject to taxation at the firm level being $12,600, but in addition workers pay taxes on the $150,000 in wages of $18,000. The total is still $30,600. 36. This chapter has spent a lot of time dealing with issues of wealth and consumption. One suggestion has been to have a tax on wealth. What are some of the benefits of this proposal? Answer: Wealth taxes help to correct certain problems that arise in the administration of an income tax, and wealth taxation reduces the concentration of wealth, which is desirable socially and politically. 37. Many states have no state-level personal income tax. How do you think that effects expenditure decisions? Answer: States that do not have income taxes rely on other sources of revenue such as excise taxes. If one believes that these taxes are regressive, then this sort of tax is falling hardest on lower income residents. However, states can choose to exempt items like food and shelter, which account for a greater percentage of spending among the poor. 38. Throughout this discussion of taxes, there has been repeated mention of the need for progressivity in the tax system. Why is this an important goal for tax systems in most societies? Answer: Society generally desires a system that says that an individual’s average tax rate should increase with income. Chapter 22 Public Finance in a Federal System Multiple Choice 1. When the federal government gives a grant to a state or local government without restrictions on use, this is known as A) revenue sharing. B) block grants. C) endowments. D) tax shelter. Answer: A 2. A circuit breaker is concerned with A) faulty tax wiring. B) residential property taxes. C) corporate tax systems. D) block grants. Answer: B 3. A Tiebout model involves A) completely mobile individuals. B) governments generating no externalities. C) perfect information. D) all of the above. Answer: D 4. When a tax is based on the difference between the market value of the taxpayer’s assets and liabilities, it is called A) a difference tax. B) a wedge tax. C) a personal net worth tax. D) an implied liability tax. Answer: C 5. For the last 100 years, the level of government that has seen the largest increase in its percentage of expenditures is A) local. B) state. C) federal. D) all of the above. Answer: C 6. When a group of people voluntarily band together to share some kind of benefit, we call this a A) a gang. B) a team. C) a coalition. D) a club. Answer: D 7. When did the percentage of federal grants in state and local expenditures reach its peak? A) 1960s B) 1970s C) 1980s D) 1990s Answer: C 8. Local property taxes are used to provide A) education. B) fire protection. C) libraries. D) all of the above. Answer: D 9. What does foundation aid do? A) increases shareholders’ net worth B) ensures minimum level of expenditures C) ensures a maximum level of expenditures D) reduces tax liability for the poor Answer: B 10. _________ percent of Americans have different residences than they did the year before. A) 30 B) 17 C) 9 D) 22 Answer: B 11. The assessed value of a home is A) the value that the jurisdiction uses to assign taxes. B) an annual 6% increase in the value of a home. C) the annual rate of deprecation of a home because of use. D) always lower than its market value. Answer: A 12. The property tax is very popular because A) it is fairly assigned. B) it is administered locally. C) it is very regressive. D) of all of the above. E) of none of the above. Answer: E 13. A local government would not be efficient in providing which of the following services? A) international aid B) police protection C) fire protection D) roads Answer: A 14. Which of the following is not a political jurisdiction? A) Cook County B) Alabama C) New York City D) California research triangle Answer: D 15. A local public good A) only benefits members of a particular community. B) gives higher benefits than regular public goods. C) requires unanimous voting. D) has become an integral part of the federal government. Answer: A 16. Disadvantages of decentralization are A) intercommunity externalities. B) forgone scale economies in the provision of public goods. C) inefficient taxation. D) the lack of ability to redistribute income. E) all of the above. Answer: E 17. __________ explores the roles of different level of government and the ways in which they relate to each other A) Federal system B) Club model C) Centralization. D) Fiscal federalism Answer: D True/False 18. Property taxes are currently unpopular. In the future, they will be more popular. A) True B) False C) Uncertain Answer: C 19. The ratio of tax collections to tax capacity is known as tax effort. A) True B) False C) Uncertain Answer: A 20. The Tiebout model assumes that public services are financed by a proportional property tax. A) True B) False C) Uncertain Answer: A 21. It is easier to avoid state and local taxes than federal taxes. A) True B) False C) Uncertain Answer: A 22. The flypaper effect causes money to move from where it initially hits and sticks somewhere down the bureaucratic chain. A) True B) False C) Uncertain Answer: B 23. The Tiebout model can be summarized as “voting with the invisible hand.” A) True B) False C) Uncertain Answer: B 24. Lump sum grants are sometimes referred to as categorical grants. A) True B) False C) Uncertain Answer: B 25. A federal system consists of one level of government to provide public goods and services. A) True B) False C) Uncertain Answer: B 26. Local property tax policy generally has a small effect on the property tax base. A) True B) False C) Uncertain Answer: B 27. Grants as a percent of total federal outlays have been increasing since the 1960s. A) True B) False C) Uncertain Answer: A 28. The proportion of total direct expenditure made by local governments is called the centralization ratio. A) True B) False C) Uncertain Answer: B 29. In Tiebout Model, the tax can vary across communities. A) True B) False C) Uncertain Answer: A Essay 30. Refer to Figure 22.3 in your textbook. Suppose that the supply curve is constant at $10. Suppose further that the before tax demand curve DB can be written as B = 20 – P/2, where B is the number of structures per year and P is the price. (A) Find B0. (B) Suppose that the after-tax demand curve, , can be written as B = 20 – P. Find B1 and . Answer: (A) Insert $10 into before-tax demand equation, and solve for B, B0 = 20 – 10/2. B0 = 15 (B) Insert $10 into after-tax demand equation, and solve for B, to get B = 20 – 10 = 10. To find , put the quantity 10 into before-tax demand equation, and solve for P = 40 – 2B = 20 31. The town of Little Bohemia has an estimated elasticity of demand for land of 2. What effect would there be to the quantity demanded from a 10% decrease in the price of land due to a tax increase? Answer: The formula for elasticity is , therefore, 2 = - (%X) / (-10) = 20. Demand would increase by 20 percent. 32. Refer to Figure 22.5 in your textbook. Suppose that the initial budget constraint AB is given by the equation G = 150 – c/5, where G is the units of public good and c is consumption. A closed-ended matching grant up to 100 units of public good is proposed. If the slope of line segment AD is – 2, write the equation of the new budget constraint after a closed-ended matching grant. Answer: For quantities of G between 0 and 100, the equation of the line is G = 375 – c/2. Using this equation at 100 units, c would be 550. In the original equation, 100 units give c to be 250, which is a difference of 300. Therefore, from the kink at D, the equation is G = 210 – c/5 from 100 to 210. 33. Suppose that the demand for housing is given by the equation Xd = 8 - P/3. If the price of housing is initially 9, what is the amount of consumer surplus? Suppose now that the price changes to 13. What happens to consumer surplus? Is there a DWL? Answer: When the price is 9, the quantity demanded is 5; therefore, consumer surplus is (½) (5) (15) = 37.5. When the price increases to 13, the quantity demanded is 3⅔. Now consumer surplus is (½) (3⅔) (11) = 20.166666. Yes, there is a deadweight loss of (½) (4) (1 ⅓) = 2⅔. 34. Refer to Figure 22.2 in your textbook. Suppose that the supply of land is constant at L acres, and Price per acre is $400. In addition, the before-tax demand for land can be characterized by the equation P = 500 – 2L, where L is the acres of land and P is the price. (A) What is the constant supply of land (L) in the market? (B) If the after-tax demand curve, , can be written as P = 400 – 4L, what is , and how much tax revenue is generated? Answer: (A) If the price is 400, then the constant acres of land will be 400 = 500 – 2(L), L* = 50. (B) At the same quantity of 50, the after-tax price will be 400 – 4(50) = 200. Tax revenue will be [(400 -200) * 50] = 1,000. 35. Some cities have a relatively high residential property tax, while others have a low residential property tax. Give an explanation for this. Answer: The number of people and their preferences for local public goods affects whether a city’s residential property tax is high or low. Property values are important in this discussion, also. The cost of living in a particular area must also be investigated. 36. The Tiebout model offers a quasi-market solution to public good production and community development. What are some drawbacks to this model? Answer: Some of the assumptions of the model are rather strong. Assuming that each individual has perfect information about all communities, taxes, and services is rather strong. In addition, assuming that there are enough communities for each individual’s preferences for a package of public goods is tough. 37. Property taxes are not very popular. People might dislike other taxes just as much, but feel powerless to change them. If the assessed value of the property does not rise or, in fact, declines, then this should be followed by decreases in tax rates. This, however, is not welcomed by property owners, either. Why? Answer: Although tax rates may be lower, this decrease corresponds to a decreasing value of the property, which will result in capital losses. The ideal situation would be for the assessed value of the property to increase with rates staying the same or decreasing. Test Bank for Public Finance Harvey Rosen, Ted Gayer 9780078021688
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