Tutorial 7 SOLUTIONS

Prepared by S. Grassi

Question 1
Is the following statement True or False? “If the social planner’s preferences are
described by the Rawlsian social welfare function and income is exogenous, the
optimal tax should equalize individuals’ consumption.” Explain.

SOL 1

False. The Rawlsian social welfare function implies that the government
maximises tax revenue to provide the largest transfer to the poorest consumer.

Question 2.
FIGURE I describes two transfer schemes to benefit those with low incomes
based on different income tax system, respectively the Negative Income Tax
(NIT) and the Negative Marginal Income Tax (or EITC). Explain the incentives
generated by the two taxation systems in panel a) and b).

FIGURE I

SOL 2:
Panel a) describes a system that is concerned with minimizing intensive margin
reactions to the tax. It provides a large transfer to those who do not work, and
then taxes it away at high rate. This system would never be optimal when labour
supply responses are concentrated along the extensive margin, because the large
transfer to those who do not work would motivate them to stay out of the labour
force.

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Panel b) describes a system that is concerned with increasing the participation to
the labour force, and so the extensive margin; the non-working poor will not
receive any benefit.

Question 3
The Participation Tax Rate (PTR) varies both by income level and by other
characteristics, notably housing tenure and family type. In 2009-2010 in the UK,
amongst couples with both partners working, couples with children have an
average PTR=0.47 (or 47%); while couples with no dependent children have an
average PTR=0.41 (41%). Which of the following statement is correct?
a) Couples with no dependent children have a stronger incentive to stay in
work.
b) Couples with children have a stronger incentive to stay in work.
c) Couples with children have stronger incentives to earn a little more.
d) Couples with no dependent children have a stronger incentive to earn a
little more.
SOL 3 a

Question 4
Present and discuss the formula for the optimal top incomes marginal tax rate
according to the model of optimal income taxation in the version where only the
intensive margin matters (the Mirrlees model) and we ignore equity.
Is it true that the optimal income tax rate for the top earners is never equal to
zero? Explain.

SOL 4:
The formula is :
1
𝑡=
1+𝑎𝑒
a is a measure of the thinness of the top tail of income distribution. As a
increases. as fewer people have high incomes.
!" ($%&)
e: is an elasticity: 𝑒 = !($%&) " that indicates the percentage change in the
average income above a threshold with respect to (1-t).
If a goes to infinity, t tends to zero. This means that taxing the top incomes is not
worth it as very few people have income larger than z*, and so the extra tax
revenue is small, however these are the most productive people and then the
efficiency loss is large.

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Question 5: On The Economic Origin of Governments
(a) Is this article supporting the “demand” or “supply” theory of the origin of
government?

SOL: Demand. This paper suggests that communities form states to solve a
coordination problem (for example that of irrigation) rather than to extract
surplus. In fact, states form where rivers shifted away rather than to.

(b) Complete the sentence using the correct words in the list below:

Our finding that states form where rivers shifted away is consistent with our
___(1)___ side hypothesis: States formed where the returns to
______(2)______, not ____(3)______, were ____(4)____.

1) supply / demand
2) solving coordination failure / expropriation
3) solving coordination failure / expropriation
4) higher / smaller
SOL
1) supply / demand
2) solving coordination failure / expropriation
3) solving coordination failure / expropriation
4) higher / smaller

(c ) How do the authors identify the causal effect of rivers shifting away on
government formation?
SOL. Discuss in class

Q6 On the Economic Origin of Government

Explain the main finding of the paper using the following Figure 1.

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 Figure 1

SOL: class discussion

Q7 On the Economic Origin of Government

What are the main results in Table 2?

SOL discussion in class