3.

Government Microeconomic Intervention Pt 4

 Objectives

• Distinction between Average & Marginal tax

• Subsidies explained
• What is Transfer payment?
 Average Vs Marginal tax rates

The average tax rate is the total amount of tax divided by total
income.

The marginal tax rate is the amount of additional tax paid for
every additional dollar earned as income..
 Calculating Marginal & Average tax
Joe has an annual income of IDR 400 Million
Income Bracket Tax owed
Tax rate Income
(IDR Million) (IDR Million)
0 - 50 5% 50 2.5
50 - 250 15% 200 30
250 - 500 25% 150 37.5
500 and above 30% - -
Total 400 70

Step 1: Split the total income into the brackets

Step 2: Calculate the tax for respective bracket
Marginal tax rate = 25%

Average tax rate = 17.5% 70 X 100 For every IDR increase

400 an additional tax of
25% needs to be paid
=17.5%
 Jane has an income of IDR 550 Million
Income Bracket Tax owed
Tax rate Income
(IDR Million) (IDR Million)
0 - 50 5%
50 - 250 15%
250 - 500 25%
500 and above 30%
Total
Calculate the Average tax rate & Marginal tax rate.

Marginal tax rate = %

Average tax rate = %

 Jane has an income of IDR 550 Million
Income Bracket Tax owed
Tax rate Income
(IDR Million) (IDR Million)
0 - 50 5% 50 2.5
50 - 250 15% 200 30
250 - 500 25% 250 62.5
500 and above 30% 50 15
Total 550 110

Calculate the Average tax rate & Marginal tax rate.

Marginal tax rate = 30 %

Average tax rate = 20 %

Comparing Joe & Jane’s tax rates if both of them have an increment of IDR 50 Million

Income Bracket Tax owed Jane’s Tax owed

Tax rate Income
(IDR Million) (IDR Million) Income (IDR Million)
0 - 50 5% 50 2.5 50 2.5
50 - 250 15% 200 30 200 30
250 - 500 25% 150 + 50 250 62.5
500 and above 30% - - 50 + 50
Total
Original Marginal tax rate = 25 % 30 %
Original Average tax rate = 17.5 % 20 %

Revised Marginal tax rate = % %

Revised Average tax rate = % %

Additional tax to be paid IDR 12.5 Million IDR 15 Million

Lets practice
 Subsidy
A subsidy is an amount of money given directly to firms by
the government to encourage production and consumption.

• In this case, the government is giving a subsidy of $14 (36-12). The subsidy
shifts the supply curve to the right.
• It leads to a lower market price. Price falls from $30 to $22.
• Quantity demand increases from 100 to 140
Deadweight loss
Lets practice
 Transfer payments

Government expenditure

With the tax revenue raised governments may spend money on such
items as:

•Pensions
•Health service
•Benefits to those out of sick, young or others unable to care for
themselves (social security payments)
•Education
•Defence
•Unemployment benefit