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1 Economics of Public Policy Week 8 Assignment To receive credit, you must submit this assignment at least one hour before next week’s lecture. Late assignments will not be accepted. 1. [Based on Gruber 18.7] Ed and Wendy are a married couple with no children. Each earns $75,000 per year, and their combined household adjusted gross income is $150,000. John and Kristen are also married and have $150,000 in combined household adjusted gross income and no children. However, Kristen earns all of the income; John does not work. Neither couple have itemized deductions, adjustments or exclusions. The 2020 standard deduction and tax rate schedule is: Single Married filing jointly Standard deduction: $12,400 $24,800 Marginal rate: 10% Up to $9,875 Up to $19,750 12% $9,876 to $40,125 $19,751 to $80,250 22% $40,126 to $85,525 $80,251 to $171,050 24% $85,526 to $163,300 $171,051 to $326,600 32% $163,301 to $207,350 $326,601 to $414,700 35% $207,351 to $518,400 $414,701 to $622,050 37% $518,401 or more $622,051 or more 1.1. Use the schedule for married couples filing jointly to compute how much income tax each couple owes. Assume that both take the standard deduction. 1.2. What is their marginal tax rate? What is their average tax rate? 1.3. Does either couple pay a marriage penalty? Does either couple receive a marriage subsidy? 2. Until 2017, taxpayers who itemize their deductions are allowed to fully deduct taxes paid to state and local governments from their federal taxable income. One rationale for this tax expenditure is that paying state and local taxes reduces an individual’s ability to pay federal taxes. Provide arguments against the federal deductibility of state and local taxes on the grounds of horizontal and vertical equity.

2 3. [This is Recitation Q3 refocused on efficiency rather than equity] Until 2017, taxpayers could deduct interest payments on up to $1 million of mortgage debt secured by the taxpayer’s residence. In addition, homeowners could deduct interest on HELOCs of up to $100,000 (HELOCs - home equity lines of credit - are like credit cards secured by the value of a home). Evaluate each of the following tax reforms (in isolation) on the basis of economic efficiency. 3.1. The deduction for mortgage interest is replaced with a non-refundable credit equal to 15% of mortgage interest payments. The rest of the tax code remains as it was in 2017. 3.2. The amount of mortgage interest eligible for deduction is lowered to $500,000 of debt. The rest of the tax code remains as it was in 2017. 3.3. The deduction for interest on HELOCs is eliminated. The rest of the tax code remains as it was in 2017.

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