Paper 3 question: USA's new tax regime (HL only)

Introduction

Donald Trump, a rank outsider to the political elite, made a reform of tax laws one of the first changes made by his administration.  This page includes a paper three type question on some of those changes.

A reminder that under the syllabus P3 questions are now graded out of thirty and contain quantitative as well as a policy questions.  

Lesson time: 50 minutes

Lesson objectives:

Paper three type question practise although this page also includes the option of discussing the impact of the new tax changes at length, for example a consideration of whether the changes to tax are more favourable for the poorest in society or the wealthiest?

New tax rates for the financial year 2018

Income earned in one year $Tax rate applied in 2016Income earned in one year $Tax rate applied under Trump
up to 18,55010%up to 19,05010%
18,550 - 75,30015%19,051 - 77,40012%
75,301 - 151,90025%77,401 - 165,00022%
151,901 - 231,45028%165,001 to 315,00024%
231,451 - 413,35033%315,001 to 400,00032%
413,351 - 466,95035%400,001 to 600,00035%
over 466,95139.6%over 600,00037%

Other changes to the income tax system

Capital gains tax to remain unchanged at 20%.

The 3.8% tax implemented as part of President Obama's health care programme to be scrapped.

The alternative minimum tax also introduced by the previous administration to be discontinued.

Corporation tax rate reduced from 35% to 21%.

More generous changes to childcare allowances will mean that many low income American families will effectively be paying zero marginal income tax.

Paper three type activity

This question is worth [30 marks]. This paper is based on the new syllabus and contains a policy response question.

1a. Define the following term:

i. Capital gains tax [2 marks]

A tax paid on the sale of assets for instance when an individual sells property at a profit.

ii. Corporation tax [2 marks]

A tax paid on profits earned by a business.

b. Are the proposed changes to income tax an example of a more progressive or regressive tax system?  [2 marks]

Largely regressive as the benefits of the tax cuts, while shared among all household income groups, benefited wealthy households more.  The eye catching headline is the elimination of tax for many low income households but in reality the wealthiest households will also see significant falls in their level of tax paid.

One mark should be awarded if the response provides an understanding of progressive / regressive taxation systems.

c. Suggest possible options for the Trump administration in order to balance the budget between government revenues collected and public spending, given the significant proposed falls in income tax rates.  [4 marks]

There are a range of options available to the new administration.

The new government could raise tax revenue from other means such as increased levels of sales tax or corporation tax.  This is unlikely however given the stated aims of the Trump campaign to create a business friendly environment.

The new administration could balance the budget by reducing government spending levels.  During the campaign Donald Trump indicated that he would scrap the previous administration's health care programme as well as demand a greater contribution from America's NATO allies, thus reducing Americas financial contribution.  With the cost of the tax cuts calculated at around $ 4 trillion however the government will need to cut public spending by considerably more than the plans so far outlined.

More realistically the new administration will simply follow the example set by previous American governments and add further to the nations enormous national debt.  This currently stands at $ 19 trillion, up from $ 10.6 under the Obama administration.  To see the exact level of US government debt in real time go to: US national debt clock

d. Calculate the level of income tax paid by the following income earners under the previous administration?  [2 marks]

  • $ 20,000
  • $ 44,510 (the average income in the country, among income earners over 15 years of age.)
  • $ 150,000

The low income wage earner would have paid the following level of income tax, calculated by (18,550 x 10%) + (1,450 x 15%) = $ 2,073.

The average earner would earn (18,550 x 10%) + (25,960 x 15%) = $ 5,749.

The high income earner would pay (18,550 x 10%) + (56,750 x 15%) + (74,700 x 25%) = $ 29,043.

Therefore the lowest income earner would pay an average tax rate of 10.37%, the average wage earner 12.91% and the highest earner would have paid an average tax rate of 19.36%.

e. Calculate the level of income tax paid by the following income earners under the proposed tax rates?  [2 marks]

  • $ 20,000
  • $ 44,510 (the average income in the country, among income earners over 15 years of age).
  • $ 150,000.

The low income wage earner would pay the following level of income tax, calculated by (19,050 x 10%) + (950 x 12%) = $ 2,019.

The average earner would earn (19,050 x 10%) + (25,460 x 12%) = $ 4,960

The high income earner would pay (19,050 x 10%) + (58,349 x 12%) + (72,600 x 22%) = $ 24,878

Therefore the lowest income earner would pay a marginal tax rate of 10.1%, the average wage earner 11.14% and the highest earner would have paid a marginal tax rate of 16.58%.

Interestingly all three tax payers in this example pay a lower average rate of income tax than the previous regime but it is the high income households that have enjoyed the greater benefit from the new tax levels.

f. Outline one benefit of both progressive and regressive tax systems? [2 marks]

One benefit of a progressive tax system is that it is considered a fairer way of collecting tax revenue, because the wealthiest households pay a greater share of the tax than families on low incomes, who are less able to pay.

There are two obvious benefits to collecting tax from regressive taxes, e.g. sales taxes.  The first is that they are much easier to collect than income taxes.  This is particularly the case in many LEDCs which suffer from a small tax base.

The second advantage is that unlike progressive tax systems, regressive ones do not provide a disincentive to work hard or set up a business.

The level of income tax in Belgium is represented on the following table:

Annual incomeTax rate inc. social security
$ 12,81038%
$ 12,811 - $ 14,70943%
$ 14,710 and $ 24,51153%
$ 24,512 - $ 44,91758%
$ 44,918 +63%

Source: //papayaglobal.com/countrypedia/country/be/

g. Calculate the level of tax paid by residents from Belgium and USA (using the 2018 tax rates) at the following income levels: [2 marks]

  • $ 30,000
  • $ 40,000
  • $ 100,000
Income levelBelgiumUSA
$ 30,000(12,810 x 38%) + (1,898 x 43%) + (9,801 x 53%) + (5,488 x 58%) = $ 14,061(19,050 x 10%) + (10,950 x 12%) = $3,219
$ 40,000(12,810 x 38%) + (1,898 x 43%) + (9,801 x 53%) + (15,488 x 58%) = $ 19,861(19,050 x 10%) + (58,349 x 12%) = $ 4,419
$ 100,000(12,810 x 38%) + (1,898 x 43%) + (9,801 x 53%) + (20,405 x 58%) + (55,082 x 63%) =  $ 57, 415

(19,050 x 10%) + (58,349 x 12%) + (22,600 x 22%) = $ 13,878

h. Calculate the average tax rate of an individual earning $ 100,000 in both countries. [2 mark]

Belgium 57,415 / 100,000 = 57.42%,  USA = 13.87%

i. Using the data provided and your knowledge of economics, recommend a policy which the US government could introduce to address the level of inequality in the nation. [10 marks]

Possible policies may include (but are not restricted to):

  • greater use of progressive taxation
  • legislation to tighten / remove tax evasion measures, which are more likey to be used by wealthy citizens to reduce their own tax burden
  • greater levels of public spending on improved access to education and health opportunities
  • higher levels of spending on out of work / welfare benefits
  • minimum wage legislation

Responses in question (i) should be graded according to the following mark bands:

Maximum mark 10

Level

Descriptor

Mark

0

The response is below the minimum standards described below.

0

1

An appropriate policy has been identified

Little economic theory is included and superficially applied.

The response contains no evidence of synthesis or evaluation

The response contains significant errors.

1 - 2

2

The response identifies an appropriate policy

Some relevant economic theory is included and one policy likely to lead to economic growth is explained

Some relevant economic terms are included

The response contains evidence of superficial synthesis or evaluation.

3 - 4

3

The response identifies and explains an appropriate policy

The response demonstrates a clear understanding of how the recommended policy might contribute to economic growth

Some relevant economic terms are used appropriately

The response contains evidence of appropriate synthesis or evaluation but lacks balance

There are minimal errors included in the response.

5 - 6

4

The response identifies and explains fully a suitable policy

Relevant economic theory is included, with the policy likely to lead to economic growth comprehensively explained and skilfully applied

The response contains evidence of appropriate synthesis or evaluation that is mostly balanced, for example a recognition that due to the relatively low PED of alcoholic drinks, policies aimed at raising the price of alcohol may be ineffective

Any errors are minor and do not detract from the overall quality of the response.

7 - 8

5

The response identifies and fully explains an appropriate policy

The response uses relevant economic theory effectively to support the recommendation Relevant economic terms are used appropriately throughout the response

The use of information from the text/data is appropriate, relevant and supports the analysis/evaluation effectively

A recognition that policies aimed at raising the price of alcohol may be ineffective due to the relatively low PED of alcoholic drinks.  Similarly marketing campaigns aimed at encouraging moderate drinking might be ignored 

The response contains evidence of effective and balanced synthesis or evaluation.

9 - 10

[end of question]

The above is available as a PDF file at: Tax changes

Answers available at: Tax responses

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