Prüfungsamt
Fachbereich Wirtschaftswissenschaften
Stand:20171
Sommersemester 2017/ summer semester 2017
Matrikelnummer / Student ID Number
Bitte auch auf jedes Blatt oben rechts eintragen! / Please also write on each page top right!
Modulkürzel / Module Code ETAX Prüfer / Examiner Prof. Dr. Alfons J. Weichenrieder
Modultitel / Module Title The Economics of Taxation
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_____________________________
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♦Please read the following instructions carefully and make sure that your copy of this exam
sheet is complete (14 pages including this one), before you proceed!

You have got a total of 90 minutes to answer all questions. The number of points next to each
question gives a rough hint on how much time it should take to answer the question. You can
score up to 90 points. If you score at least 45 points, you will definitely pass the exam.

Below each question, you will find a box. Write down your answer in this box! Only answers
written in the box will be graded. You may use the empty parts of each sheet. These notes will
NOT be graded. If you run out of space inside a box, you may use the backside of a sheet to
continue your answer. This answer will be assessed if and only if it is sufficiently separated
(e.g. by a frame) from other notes and if there is a hint inside the box that shows us where to
find your answer.

You may use pocket calculators.

Good luck!

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Problem 1 (Tax Scale and Income Splitting, 12 points)
Consider the following tax scale for individuals.
Income bracket (€) Marginal tax rate 𝑇’(𝑦)
𝑦 ∈ [0; 8,000] 0
𝑦 ∈ (8,000; 20,000] 0,15
𝑦 ∈ (20,000; 60,000] 0,25
𝑦 ∈ (60,000; 120,000] 0,4
𝑦 ∈ (120,000; ∞] 0,5

(a) (6 points)
Suppose in a family, one partner earns 120,000 € while the other partner earns 20,000 €.
Calculate the tax burden under income splitting. How big is the splitting advantage?

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(b) (6 points)
Now assume that, similar as in France, family income splitting is practised: the sum of taxable
incomes is divided by the weighted number of family members, with both partners having a
weight of 1 each. Suppose the first two children has a weight of 0.5 each and all additional
children a weight of 1 each.
Considering the above tax scale for individuals, what is the tax burden of this family in the
case of family income splitting if the family has three children?

Problem 2 (Tax Shifting With Imperfect Markets, 10 Points)

Consider a monopolistic market with a linear demand 𝑥 = 𝑎 − 𝑏𝑝, where p is the price and a
and b are positive parameters. The monopolist faces constant marginal cost 𝑐 and produces 𝑥.
Show that in this case exactly half of a specific tax (tax rate 𝑡) will be shifted into consumer
prices.

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Problem 3 (Excess Burden of Taxation, 20 Points)

Consider an individual who consumes two goods x and y. Her indirect utility function is
M - py
V(M, px ,p y ) =
4 p x with M representing the budget, p x the price of one unit of x and p y
the price of one unit of y.

(a) (4 points)
Calculate the expenditure function!

(b) (14 points)

Consider an economy with a representative individual who is consuming two goods. The
government introduces a new ad valorem tax of 50% on good x, good y stays untaxed. The
old prices were p x = 4 and p y = 4. The individual’s budget is M = 124 and producer prices

are constant.

Calculate the excess burden of taxation using the compensating variation!

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(c) (2 points)

Explain verbally the meaning of equivalent variation! (2 points)

Problem 4 (Optimal Taxation, 9 points)

(a) (2 points)
Consider a situation with two consumption goods (1 and 2) and the good “leisure” (good 0)
that cannot be taxed. What are the assumptions to obtain the inverse elasticity rule?

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(b) (3 points)
What is the policy implication of the Corlett-Hague-Rule?

(c) (4 points)
What is the fundamental message of the production efficiency theorem? What are the
necessary assumption(s)?

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Problem 5 (Taxation of External Effects, 18 Points)
(a) (8 points)
Explain what is generally meant by environmental pressure groups when claiming a double
dividend of environmental taxation! In the academic literature, one may distinguish between
a strong and a weak “double dividend” hypothesis. Explain!

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(b) (10 points)
The marginal environmental damage (externality) that arises from the consumption of a dirty
good may be either constant or increasing in total consumption. To which extent should the
rate of an optimal Pigouvian tax then depend on the price of the dirty good? Should the tax
be increased, decreased or held constant if the producer price of the dirty good decreases?
What is your conclusion if the lower price of the dirty good comes from a lower demand? You
may use adequate graphs to explain your arguments.

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Problem 6 (Tax Shifting in Open Economies, 15 Points)
Consider the following graph. There are two factors: factor K (“capital“) is mobile between
the two countries A and B, whereas factor L (“land”) is immobile. The production functions
are F(KA) and G(KB), where KA and KB are employed in country A and B. Production is
assumed linear homogenous. The price of output equals unity and the endogenous real
interest rate is denoted by r. Point E characterizes the equilibrium without taxes: Marginal
productivities F’ and G’ equal the real interest rate r0.

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Now suppose that country B introduces a tax t on capital KB. The new equilibrium is given in
point J. In the following you are expected to analyze the consequences of this tax. Please
indicate the corresponding areas naming the corners (in clockwise order).
r, G’ r, F’
A
B
G’ F’

t D
C
E
M r0 L
r
H 1 I
J N

KB K1 K0 KA

(a) What area represents the reduction of worldwide capital income? (3 points)

(b) What area represents the reduction of income of land owners in country B? (3 points)

(c) What area represents the increase of income of land owners is country A? (3 points)

(d) What area represents the tax revenues? (3 points)

(e) What area represents the loss in worldwide production? (3 points)

Problem 7 (Optimal Income Tax, 6 Points)

Assume a government wants to maximize the utility of NH high ability individuals subject to
a minimum utility for NL low ability individuals, which is above the attainable utility level in
the absence of redistribution. Set up the Lagrangian of the problem and explain the
restrictions included.

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