School of Business and Economics

EXAMINATION Version:

Course : Design of Tax Systems Code: EBC2017

Coordinator(s): Max Löffler
Date : ***** Time: **:**-**:**
Location : *****

Communications devices and watches are not allowed—put them in your bag
(under your table) or on the floor, not within arm’s reach! Otherwise this
will be reported as possible fraud to the Board of Examiners.

Any changes to the examination after the official end of the examination will be reported as
possible fraud to the Board of Examiners.

Sanctions by the Board of Examiners on fraud or irregularities include such measures as:
- complete or partial voidance or annulment of the relevant examination;
- exclusion from participation or further participation of one or more examinations or
exams at the SBE for a period of time to be determined by the Board of Examiners, with
a maximum period of one year;
- termination of the student’s registration for the concerning study programme.

This examination consists of: (please check if you received all pages, before you start
answering)
• 3 pages (front page included)
• 11 questions

You are allowed to make use of:

• A non-programmable calculator: only the models Casio FX82 and FX85 are allowed.

Norm:
• A total of 100 points can be scored on this examination. You pass this examination if
and only if you score 50 or more points.

Publication of the results: within 15 workdays

Procedure for objections:

Comments: Any comments about the examination itself must be delivered via a link—provided
via the course page in “My Courses”—at the latest five days after the examination date.
Complaints: Within ten working days of the publication of your official examination results in
“My Courses >> Show results”, you will be able to have a look at your assessed work (exam
inspection). In case you disagree with the grading, you can then file a complaint to your course
coordinator. You can find the inspection date via the course page in “My Courses”.

Particulars:
• Read the questions carefully before answering.
• Your answers have to be written in English.
• Write your student id number on all your answer sheets.

You have to hand in the entire examination set. It is not allowed to take
home, copy or photograph the examination or parts of it!

1
Question 1. Give short and precise definitions/explanations for each of the following
terms:
a. (2 points) Lock-in effect
b. (2 points) Ramsey rule
c. (2 points) Horizontal equity
d. (2 points) Haig-Simons definition of income
e. (2 points) Laffer curve
f. (2 points) Tax credit

Question 2 (9 points). Discuss the income and substitution effects of a lump sum tax.
Does a lump sum tax result in excess burden? Why (not)? Illustrate your answer graphically
using an indifference curve diagram.

Question 3. Consider the following tax schedule. The tax liability of a single person with
income I, or of a married couple with total income I, is given by T(I) = – a + tI. Both a and
t are positive numbers. Determine for each of the following three principles whether or not
the principle is satisfied by this tax schedule:
a. (3 points) progressiveness,
b. (3 points) equal taxation of married couples with equal total incomes, and
c. (3 points) marriage neutrality.

Question 4. In 2002, New York City increased the tax rate on cigarettes from $0.08 a
pack to $1.50 a pack. A month after the increase, a spokesman for the mayor noted that
“fewer cigarettes are being sold, and the city is making more money”. Assume for
simplicity that the supply of cigarettes to New York City is perfectly elastic.
a. (4 points) Assuming that the spokesman’s facts are correct –– i.e., less cigarettes
are sold, and tax revenue has increased –– what must be true of the elasticity of the
demand? Illustrate graphically.
b. (4 points) Recall that the spokesman’s comment was made just one month after
the tax increase was enacted. As more time passes, what do you expect to happen
to the elasticity of the demand curve, and how will this affect tax revenue for New
York City? Illustrate graphically.

Question 5. Give and explain

a. (4 points) two advantages and
b. (4 points) two disadvantages of a system of decentralized governments.

2
Question 6 (8 points). With a progressive tax structure (a typical one that assigns a
different marginal tax rate to each tax bracket), how does an increase of the lowest
marginal tax rate affect the labor supply of people in the lowest brackets? And how does it
affect the labor supply of people in higher brackets? Illustrate your answer graphically.

Question 7 (9 points). Assume that a consumer has preferences over consumption and
leisure described by U = x(1 – l), where x is consumption and l is labor. For a given wage
rate w, which leads to a higher labor supply: an income tax at a constant rate t or a lump-
sum tax T that raises the same revenue as the income tax?

Question 8 (9 points). Describe and compare the following three types of consumption
taxes: (i) the value-added tax, (ii) the Hall-Rabushka flat tax, and (iii) the cash-flow tax.

Question 9 (10 points). Suppose the demand for good X can be represented by X = 20 –
0.4PX and the demand for good Y by Y = 30 – PY.
a. (4 points) First, find the elasticity of demand for both good X and Y if the price of
both goods is €10.
b. (6 points) Second, suppose that an ad valorem tax is placed on both goods. Good Y
is taxed at a rate of 7%. To ensure that the inverse elasticity rule holds, what must
be the rate at which good X is taxed?

Question 10 (9 points). Explain carefully why debt finance may be preferable to tax
finance if one wants to minimize excess burden.

Question 11. Define and explain the following three types of conditional intergovernmental
grants, and in each case illustrate your answer using an indifference curve diagram:
a. (3 points) matching grant,
b. (3 points) matching closed-ended grant,
c. (3 points) nonmatching grant.

In case you finish the examination early:

Please leave the examination hall as quietly as possible, so you do not disturb your fellow
students still concentrating on their work!