When filing an income tax return, one can claim a deduction for charitable contributions. Let's simplify the income tax system and assume that the tax is proportional to the level of taxable income (income after deductions).

Microeconomic Theory
12th Edition
ISBN:9781337517942
Author:NICHOLSON
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Chapter4: Utility Maximization And Choice
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When filing an income tax return, one can claim a deduction for charitable contributions. Let's simplify the income
tax system and assume that the tax is proportional to the level of taxable income (income after deductions).
(a) Suppose we increase the marginal income tax rate. An economic adviser claims that the effect of this tax change on
the amount of charitable contributions is uncertain. Plot a simple graph that illustrates this situation (it involves
the choice between charitable contributions and other spending), use it to explain why the effect is uncertain and
explain what it depends on.
(b) Now suppose that we instead increase the marginal tax rate but also provide a transfer that makes the bundle
that used to be optimal before tax increased just affordable. According to the economic adviser this policy change
will make people contribute more to charity. Why?
Transcribed Image Text:When filing an income tax return, one can claim a deduction for charitable contributions. Let's simplify the income tax system and assume that the tax is proportional to the level of taxable income (income after deductions). (a) Suppose we increase the marginal income tax rate. An economic adviser claims that the effect of this tax change on the amount of charitable contributions is uncertain. Plot a simple graph that illustrates this situation (it involves the choice between charitable contributions and other spending), use it to explain why the effect is uncertain and explain what it depends on. (b) Now suppose that we instead increase the marginal tax rate but also provide a transfer that makes the bundle that used to be optimal before tax increased just affordable. According to the economic adviser this policy change will make people contribute more to charity. Why?
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