Question

The Commonwealth of Massachusetts, seeking additional tax revenues plans to levy an additional tax on all pizza. The state legislature offers the governor two alternative tax plans to select from. The first plan calls for a $1.00 per pizza tax and the second plan calls for a tax based on a rate of 11 percent of total revenue from pizza sales. As manager of the Massachusetts division of Ian Pizza you must decide which plan to lobby for. Assume the tax is inevitable and the objective of the company is to still maximize revenues. Now, however, revenues are net revenues. Net revenues are total revenue minus the firm’s tax bill.

    

a. What will be the company’s net revenues under the flat tax plan?

b. What will be the company’s net revenues under the 11 percent tax plan?

c. Based on your findings in parts (a) and (b) above which plan is best for Ian pizza?

Answer 1

a. Suppose the company sells 100 pizzas of $10 each.

In this case:

Total Revenue = 100*10 = $1000 (Total Revenue= Price*Quantity)

If the company levies the flat tax plan then it charges $1/pizza as tax

In this case:

Tax= 1*100 =$100

Therefore, Net Revenue of the company under this plan:

Net Revenue= Total Revenue-Tax = $1000-$100 = $900

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b. Here also we assume that the company sells 100 pizzas of $10 each.

In this case:

Total Revenue = 100*10 = $1000 (Total Revenue= Price*Quantity)

If the company levies the tax under 11 percent tax plan then in this case

Tax= 11 percent of Total Revenues = 11 percent of $1000 = $110

Therefore Net Revenues in this case will be:

Net Revenues= Total Revenue - Tax = $1000 - $110 = $890

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c. Since the company's objective is to maximize net revenues, then based on the above calculations and results the company should go for the flat tax plan. This is so because it gives the company higher net revenues when we have assumed that the company is earning same revenues in the above two situations.