Question

1.

a. The country of Smokey is considering imposing a cigarette tax. Assume that the demand for cigarettes is perfectly inelastic and that before any tax is imposed the price per pack of cigarettes was $10. Assume all individuals in Smokey smoke 200 packs of cigarettes per year and the government imposes a unit tax of $5 per pack of cigarettes. Is the tax progressive, proportional or regressive? Explain your answer.

b. Assume all individuals in Smokey spend 30% of their income on housing. The government imposes a tax on housing that raises the price of housing by 10 percent. Is the tax progressive, proportional or regressive? Explain your answer.

Answer 1

Ans a.) Regressive

Given that the demand for cigarette is perfectly inelastic, therefore the whole burden of tax will be borne by the consumer.under regressivve tax system, individuals with low incomes pay a larger share of income in taxes compared to high-income earners Here the amount of tax is fixed for every buyer and does not change with income. But the poor spends a larger proportion of their income to buy a pack of cigarette than a rich person, therefore we can say that the tax is regressive. This is an example of a sin tax.

Ans b.) Proportional

A proportional tax system is the one where a flat tax rate is imposed regardless of the person's income or wealth. In this example, there is 10% tax on housing regardless of the type of consumer i.e rich or poor therefore we can say this is an example of proportional tax.

Suppose income of poor is $100 and the income of the rich is $1000. Initiall they used to spend 30% of their income on housing. So the poor person would spend $30 and the richer person would spend $300. now with a tax of 10%, poor person would have spend $33 for the same housing and the same is $330 for the richer person . So the proportionate increase is same for both the category.