Poverty — practice questions

(a) Individual earning $40,000

1. Tax on first $10,000: This falls within the Personal Allowance.
   • Tax = $10,000 \times 0\% =$0
2. Tax on income from $10,001 to $40,000: The amount in this band is $30,000 ($40,000 - $10,000). This is taxed at the Basic Rate.
   • Tax = $30,000 \times 20\% =$6,000
3. Total Tax Paid:
   • Total Tax = $0 + $6,000 = $6,000
4. Average Tax Rate: This is the total tax as a percentage of total income.
   • Average Rate = $\frac{6000}{40000} \times 100\% = 0.15 \times 100\% = 15\%$

** (b) Individual earning $80,000**

1. Tax on first $10,000:
   • Tax = $10,000 \times 0\% =$0
2. Tax on income from $10,001 to $50,000: The full amount in this band is $40,000 ($50,000 - $10,000). This is taxed at the Basic Rate.
   • Tax = $40,000 \times 20\% =$8,000
3. Tax on income above $50,000: The amount in this band is $30,000 ($80,000 - $50,000). This is taxed at the Higher Rate.
   • Tax = $30,000 \times 40\% =$12,000
4. Total Tax Paid:
   • Total Tax = $0 + $8,000 + $12,000 = $20,000
5. Average Tax Rate:
   • Average Rate = $\frac{20000}{80000} \times 100\% = 0.25 \times 100\% = 25\%$

Conclusion on Progressivity: The tax system is progressive because the average tax rate increases as income increases. The individual earning $40,000 pays an average rate of 15%, while the individual earning $80,000 pays a higher average rate of 25%. This demonstrates the principle of vertical equity.

Equity effects:

• Progressive tax rise increases vertical equity — high earners contribute a larger share, narrowing post-tax income gap.
• Higher benefits raise disposable income for unemployed/low-income households — reduces poverty and likely lowers Gini.

Efficiency / incentive effects:

• Top earners may reduce labour supply or relocate (tax avoidance) — efficiency loss and possible Laffer curve concern if revenue falls.
• Higher benefits may reduce job-search intensity (unemployment trap) — structural unemployment risk.
• Deadweight loss from higher marginal tax rates on middle/high earners.

Judgement: Short-run equity gains are likely; long-run effectiveness depends on behavioural responses and whether revenue funds productive spending (education, health) that raises human capital — potentially improving both equity and efficiency over time.