Question

The U.S. Senate is considering a bill that would tax the sale of laptop computers in order to fund a computer education program for presidential hopefuls. The Congressional Budget Office (CBO) estimates that if it implements a low tax of $12 per laptop, revenue should be sufficient to exactly fund the program. The CBO also estimates that a high tax of $230 per laptop will exactly fund the program.

A) How can both a low tax and a high tax raise exactly enough money to fund the program? Explain with a diagram.
B) Suppose you are an economic advisor to the Senate Finance Committee, tasked with analyzing the economic impact of the tax proposals. Which proposal do you recommend, and why?

Answer 1

Answer is explained in the explanation section below.

Step-by-step explanation:

Solution:

Part A:

The tax revenue is =
`Q_(laptop)` x TAX

As the tax rate increases, lesser number of laptops are being sold in the market. According to question the two schemes generate the same taxation revenues, this means

`Q_(Tax 12USD)` x $12 =
`Q_(Tax 230USD)` x $230

When the tax rate is low, there is a sufficiently large number of laptops sold.

When the tax rate is sufficiently high, even a lower number of laptops sold generates enough revenue.

Part B:

It's provided that both proposals raise the identical taxation revenues, the relevant determining factor is the size of deadweight loss (DWL).

Given that DWL arises from lost transactions due to the quantity effect, it must be the case that the low tax rate proposal is to be preferred in order to minimize the number of lost transactions thereby minimizing DWL.

Hence, Low tax rate proposal is recommended.