Economics Micro & Macro (CliffsAP)

Taxation

One way to reduce poverty is to increase the level of disposable income people have. Some economies adopt an approach
that taxes the rich heavily and taxes the poor lightly. You will need to know about three types of taxes for the AP exam:

■ Progressive tax:A tax that rises as income rises. As an individual’s income rises, the percentage of income that

goes to taxes also rises.

■ Proportional tax:A tax whose rate does not change as the tax base changes. If the proportional tax rate is 25 per-

cent, then no matter what income an individual earns, she pays 25 percent of her income to taxes. The percentage

stays the same but the amount varies. Twenty-five percent of $100,000 is a lot less than 25 percent of $1,000,000.

■ Regressive tax:A tax whose rate decreases as the tax base changes. Social security tax is an example of a regres-

sive tax. As an individual earns more, the amount taxed stays the same.

Progressive taxes tend to reduce income inequality; proportional taxes do not affect income distribution; and regressive
taxes increase inequality. Progressive taxes take a higher percentage of income from the rich or upper class than it takes
from the middle or the poor. The progressive tax tends to equalize income distribution in the United States. Figure 11-7
shows the impact a tax has on a producer.

Figure 11-7

The tax on a supplier lowers its quantity produced and increases its price. The government can use taxation to limit the
production of a specific good, or it can use taxation to increase the production of a certain good. Depending on its im-
pact on society, the government can regulate a firm’s or industry’s output.

Review Points

■ The economy experiences efficiency when producers are responsible for all costs; if they are not, spillover costs

are created.

■ Externalities are considered market failure because either producers are failing to bear all of the costs or buyers

are not the only beneficiaries of the goods and services produced.

■ Public goods are nonexclusionary. People who pay as well as those who do not pay have access to the public

good.

Q^1 Quantity

Price

Q^2

P^1

P^2

S (no tax)

D

S^2 (with tax)

Part III: Microeconomics