Government Aims and Fiscal Policy: Question 7

Worked solution

Part (a): Average tax rate for each person

The average rate of tax is the tax paid expressed as a percentage of income.

For Person C, on an income of $15,000: $\frac{600}{15000}\times100 = 4\%$

For Person D, on an income of $90,000: $\frac{600}{90000}\times100 \approx 0.67\%$

Part (b): Progressive, regressive or proportional?

A tax is progressive if the average rate rises as income rises, proportional if the average rate stays the same at every income level, and regressive if the average rate falls as income rises.

Here, Person D earns six times as much as Person C, but both pay the same $600 fee. As a result, Person D’s average rate (about 0.67%) is far lower than Person C’s (4%). Because the average rate of tax falls as income rises, Kelmoor’s flat-fee health contribution is a regressive tax.

Part (c): Why a flat-fee tax can be considered unfair

One widely used principle of taxation is that tax should be charged according to a person’s ability to pay. Those with higher incomes, and therefore greater capacity to contribute, should pay a larger share of their income in tax. Kelmoor’s flat $600 fee ignores this principle entirely: it takes the same dollar amount regardless of income, so it swallows a much bigger proportion of a low earner’s limited income than of a high earner’s income. Person C effectively sacrifices six times as large a share of their income as Person D does, even though Person D can far more easily afford the $600 charge. This is why flat-fee and other regressive charges are often criticised as unfair on ability-to-pay grounds.

Final answers

• (a) Person C’s average rate is 4%; Person D’s average rate is about 0.67%.
• (b) The tax is regressive, since the average rate falls as income rises.
• (c) A fixed fee takes a far larger share of a low earner’s income than a high earner’s, breaching the ability-to-pay principle.