Government Aims and Fiscal Policy: Question 4

Worked solution

Part (a): Tax paid by Person A ($20,000 income)

Person A earns $20,000. Apply Norvale’s bands in order:

• First $8,000: tax-free, so tax on this part $= 0$.
• Remaining income $= 20000 - 8000 = 12000$, taxed at 10%:

$0.10 \times 12000 = 1200$

Total tax paid by Person A $= 0 + 1200 = \boxed{1200}$, i.e. $1,200.

Part (b): Tax paid by Person B ($60,000 income)

Person B earns $60,000, which spans all three bands:

• First $8,000: tax-free, so tax on this part $= 0$.
• Next band, from $8,000 to $30,000, is $30000 - 8000 = 22000$ wide, taxed at 10%:

$0.10 \times 22000 = 2200$

• Remaining income above $30,000 is $60000 - 30000 = 30000$, taxed at 25%:

$0.25 \times 30000 = 7500$

Total tax paid by Person B $= 0 + 2200 + 7500 = \boxed{9700}$, i.e. $9,700.

Part (c): Average tax rates and the type of tax system

The average tax rate is total tax paid divided by total income, expressed as a percentage. This is different from the marginal rate, which is just the rate charged on the last band of income reached.

For Person A: $\frac{1200}{20000} \times 100\% = 6\%$

For Person B: $\frac{9700}{60000} \times 100\% \approx 16.2\%$

Person B, who earns three times as much as Person A, pays tax at a noticeably higher average rate (about 16.2% compared with 6%). Because the proportion of income paid in tax rises as income rises, Norvale’s income tax system is progressive.

Final answers

• (a) Person A pays $1,200 in tax.
• (b) Person B pays $9,700 in tax.
• (c) Average tax rates are 6% (Person A) and about 16.2% (Person B); since the average rate rises with income, the system is progressive.