Question

Suppose the government wants to increase the ability of families to pay for college education. Would a $1000 income tax rebate differ from a $1000 tax credit for tuition reimbursement? Explain using indifference curve and budget line analysis.

Answer 1

A tuition rebate and income tax rebate are both different scenarios. In the income tax rebate, the income of family will increase while in the tuition rebate is like a decrease in the price of the certain good. In the tuition rebate, there will be both substitutions as well as income effect whereas in the case of income tax rebate there will only be an income effect. Families will certainly be worse off in the case of tuition rebate as they have to substitute away from their preferred goods. They must be happier if they are able to freely allocate their income. But if the main goal is to enhance the level of education then tax credit is better.

In the first case, there is a tax rebate. There will be a rightward shift of budget line due to increase in income as a result of a tax rebate. The families will be able to get to the higher indifference curve due to increase in their income.

In the second case, there is a tax credit which is same as a decrease in the price of tuition fees. The decrease in a price of a normal good lead to both the substitution as well as income effect. The families will shift increase the education as a result of decrease in its price