Assignment #2: Answers
- The debate regarding a reduction in income tax for the middle class and an increase in income tax for incomes greater that $200,000 is still ongoing. A reduction in middle class taxes coupled with an increase in tax on higher incomes is equitable. Some argue that high income earners create jobs and are comprised of small business owners, and increasing their taxes will stall job creation and thus slow the economy. Others argue that increases would be minimal and would lead to greater wealth creation for all and thus stimulate the economy.
- Step 1: Total income = $100,000
Step 2: Subtract Deductions: childcare expenses [$7,000] RPP contributions [$26,010]
Taxable income = $100,000 – ($7,000 + $26,010) = $66,990
Step 3: Statutory marginal tax rate = 17%
Income tax before tax credits = $66,990 * 0.17 = $11,388.30
Step 4: Subtract tax credits:
charitable donations [$200*0.15] = $30
medical expenses [$20,000 – ($66,990 * 0.03)] = $3,598.06
Federal tax payable = $11,388.30 – 3628.06 = $7,760.24
Effective marginal tax rate = $7,760.24/$66,990 = 11.6%
3) Contributions to a RRSP, and the investment income earned, are not taxed until paid out. Investment in a TFSA is taxable, but the investment income and withdrawals are not taxable. If you expect your future income to be higher than your present income, then investment in a TFSA is preferred. Pay tax now rather than face a higher rate in the future. If you expect your future income to be less than present income, then contributions to a RRSP is preferred. Defer tax to a period with a lower rate.
- Individuals as the taxable unit:
Mr. Smith’s tax liability = ($40,000 * 0.10) + ($25,000 * 0.25) = $10,250
Mrs. Smith’s tax liability = $10,250
Total liability for the family = $20,500
- Family as the taxable unit:
Mr. and Mrs. Smith’s (family) income = $130,000
Mr. and Mrs. Smith’s tax liability =
($40,000 * 0.10) + ($60,000 * 0.25) + (30,000 * 0.35) = $29,500
- Yes, the tax liability differs and therefore the choice of taxable unit matters. The Smith’s pay more tax when the family is the taxable unit than when the individual is the taxable unit. When family is the taxable unit, they face the highest marginal tax bracket (35%), while individually they do not.
- There is more incentive for Canadians to locate based on taxes, as their tax liability depends on where they live. Americans on the other hand face less of an incentive as they pay taxes no matter where in the world they live. There are production implications as US firms may end up paying more for labour and be at a cost disadvantage. The residential and production effects move in opposite directions with regards to efficiency.
- A “rational” individual does not always reduce labour supply in response to a proportional income tax. Why? There are two effects generated by the tax:
- Substitution effect – Decrease labour supply
- Income effect – Increase labour supply
Whether labour supply decreases or increases in response to a proportional income tax depends on which effect dominates.