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The Case:


Public revenues are received by Government from different sources like taxes (income and sales tax), administrative activities which include fines, fees, grants and gifts etc. Furthermore, it is an important tool of the fiscal policy and is the opposite factor of government expenditures. Government need to perform various functions in the field of political, social and economic activities to maximize social and economic welfare. In order to run the economy in a better way, government needs to have a large amount of revenues. As tax payers are major contributors of public revenues, if we categorize the tax payers according to their percentage of tax paid we will find that the richest pays more and the poorest pays less. Suppose last year total income tax revenue was 700 billion collected from all different income groups.


Given below, the categories of income groups with percentage of each category in population and their total income tax revenue.




Percentage of each category in population

Pays (Total Income tax revenue)

The richest


57% (399 billion)

The middle class


25% (175 billion)

The lower middle class


13% (91 billion)

The bottom (poor)


5% (35 billion)














Keeping in view the above case analyze that how a decrease of one percent in income tax by government will affect the revenue and its contribution towards economic welfare? Explain logically

Important Instruction:


Write to the point and precise answer. Avoid irrelevant and extra details.

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Replies to This Discussion

is ko calculate to ni kurna na ????


or 30 marks hain ziada likhna parega 

Write to the point and precise answer. Avoid irrelevant and extra details.

More Discuss...  

Govt. decrease 1% tax k jo affect hogay un ko all categories rich, middle, lower middle aur poor may batana ho ga.

The Facts behind the Calculations

First, in the U.S., a household is in the top 1 percent of the income distribution if its income is, roughly, above $400,000 per year. That means that the proposed top marginal income-tax rate would apply only to income accrued beyond $400,000. Income up to that level would be taxed at rates for lower income levels.

Second, the average household in the top 1 percent of the income distribution makes approximately $1.3 million per year. This means that on a per household basis, $900,000 (that is, $1.3 million minus $400,000) of the income would be subject to the proposed top marginal income tax.

Third, the net-of-tax rate is defined as the percentage of income earned beyond $400,000 that the household can keep after taxes. If the top income-tax rate is 42 percent, the net-of-tax rate would simply be 58 percent (that is, 100 minus 42 percent). Researchers estimate that when the net-of-tax rate falls by 1 percent, top-income households react by reducing their reported income by a fraction e, where e is between 0.17 and 0.57 (that is, between 17 and 57 percent).

These estimates are based on information collected over a few years after a tax reform. Unfortunately, there is no direct evidence of what happens with reported incomes over a longer time horizon.

The reaction of reported income to higher taxes is called the "short-run behavioral response" of the household, and it occurs partly because higher taxes lead high-income persons to work fewer hours per year. Technically, e is called the elasticity of reported income with respect to the net-of-tax rate.

With these facts in hand, suppose that the government is considering increasing the top income-tax rate from its current level, say, by 1 percentage point. Diamond and Saez take into account two effects of this increase on government tax revenue. The first effect increases revenue, and the second decreases revenue.

First, tax revenue is going to increase because top-income households are taxed more heavily. Keeping everything else constant, the increase in the revenue extracted from each top-income household would be exactly equal to 1 percent of $900,000, that is, $9,000 per household.

Second, Diamond and Saez consider the short-run behavioral response. As the tax rate is increased by 1 percentage point, the net-of-tax rate decreases by a certain percentage, and households react to this by decreasing their income. This reduction causes a fall in government revenue simply because less than $900,000 would be effectively taxed per household. This reduction is known as the "deadweight loss" from taxation. Diamond and Saez use the estimated behavioral responses that we cite above in order to calculate the magnitude of the reduction in income by top-income households when tax rates go up.

Whether increasing taxes would lead to more revenue will depend on which of the two effects is stronger. If the first effect is stronger, the government can increase revenue by increasing taxes. If the deadweight loss is stronger, then the government could raise more revenue by decreasing taxes. Intuitively, the first effect is stronger when the tax rate is low, while at high tax rates the behavioral response dominates.4 Therefore, government revenue would increase at low tax rates and decrease at high tax rates. This leads to a bell-shaped plot known as the Laffer Curve, which relates tax rates to government revenue. A formula for the Laffer Curve considered by Diamond and Saez is given in the box below.

Panels A and B plot the income of the average top-income household and the Laffer Curve considered by Diamond and Saez for two values of e.5 The blue dotted line in each panel of the figure shows how the income of the average top-income household falls as the tax rate increases. Panel A has a lower value of e, which implies that the behavioral response is smaller; so, income falls more slowly than in Panel B, where the value of e is higher. The red solid line shows the Laffer Curve, which simply plots revenue (R, from the formula in the box) as a function of the tax rate (t in the box). As expected, tax revenue increases when the tax rate is low and decreases when the tax rate is high.

ko tou concept clear karo?

is main logically bta hai numerical kuch bhe nahi hai aj sir ny uni main batya tha ..

Question ky end pu likha hua hai explain logical ...


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