Solutions Manual—Taxation of Individuals, by Spilker et al. Solutions Manual—Taxation of Individuals, by Spilker et al.
based upon their tax rhetoric. Likewise, the major political parties generally have
Solution Manual For very diverse views of the appropriate way to tax the public. Determining who is
McGraw-Hill's Taxation of Individuals 2024 Edition, taxed, what is taxed, and how much is taxed are difficult questions. Voters must
15th Edition Spilker have a basic understanding of taxes to evaluate the merits of alternative tax
proposals offered by opposing political candidates and their political parties.
Chapter 1-14
(4) [LO 2] Courtney recently received a speeding ticket on her way to the university.
Chapter 1 Her fine was $200. Is this considered a tax? Why or why not?
An Introduction to Tax
The $200 speeding ticket is not considered a tax. Instead, it is considered a fine
or penalty. Taxes differ from fines and penalties because taxes are not intended
Discussion Questions to punish or prevent illegal behavior.
(1) [LO 1] Jessica’s friend Zachary once stated that he couldn’t understand why (5) [LO 2] Marlon and Latoya recently started building a house. They had to pay
someone would take a tax course. Why is this a rather naïve view? $300 to the county government for a building permit. Is the $300 payment a tax?
Why or why not?
Taxes are a part of everyday life and have a financial effect on many of the major
personal decisions that individuals face (e.g., investment decisions, evaluating The building permit is not considered a tax because $300 payment is directly
alternative job offers, saving for education expenses, gift or estate planning, etc.). linked to a benefit that they received (i.e., the ability to build a house).
(2) [LO 1] What are some aspects of business that require knowledge of taxation? (6) [LO 2] To help pay for the city’s new stadium, the city of Birmingham recently
What are some aspects of personal finance that require knowledge of taxation? enacted a 1 percent surcharge on hotel rooms. Is this a tax? Why or why not?
Taxes play an important role in fundamental business decisions such as the The 1 percent surcharge is a tax. The 1 percent surcharge is an earmarked tax –
following: i.e., collected for a specific purpose. The surcharge is considered a tax because
the tax payments made by taxpayers do not directly relate to the specific benefit
What organizational form should a business use?
received by the taxpayers.
Where should the business locate?
How should business acquisitions be structured? (7) [LO 2] As noted in Example 1-2, tolls, parking meter fees, and annual licensing
How should the business compensate employees? fees are not considered taxes. Can you identify other fees that are similar?
What is the appropriate mix of debt and equity for the business?
Should the business rent or own its equipment and property? There are several possible answers to this question. Some common examples
How should the business distribute profits to its owners? include entrance fees to national parks, tag fees paid to local/state government
One must consider all transaction costs (including taxes) to evaluate the merits of for automobiles, boats, etc.
a transaction.
(8) [LO 2] If the general objective of our tax system is to raise revenue, why does the
Common personal financial decisions that taxes influence include: choosing income tax allow deductions for charitable contributions and retirement plan
investments, retirement planning, choosing to rent or buy a home, evaluating contributions?
alternative job offers, saving for education expenses, and doing gift or estate
planning. In addition to the general objective of raising revenue, Congress uses the federal
tax system to encourage certain behavior and discourage other behavior. The
charitable contribution deduction is intended to encourage taxpayers to support
(3) [LO 1] Describe some ways in which taxes affect the political process in the the initiatives of charitable organizations, whereas deductions for retirement
United States. contributions are intended to encourage retirement savings. Another objective of
the tax system is to redistribute wealth.
U.S. presidential candidates often distinguish themselves from their opponents
© McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC. © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.
1 2
, Solutions Manual—Taxation of Individuals, by Spilker et al. Solutions Manual—Taxation of Individuals, by Spilker et al.
(9) [LO 2] One common argument for imposing so-called sin taxes is the social goal Effective Tax Rate =
Total Tax
of reducing demand for such products. Using cigarettes as an example, is there a Total Income
segment of the population that might be sensitive to price and for whom high
taxes might discourage purchases? The effective tax rate provides a depiction of a taxpayer‘s tax burden because it
depicts the taxpayer‘s total tax paid as a ratio of the sum of both taxable and
The most obvious segment sensitive to price may be teenagers and younger adults nontaxable income earned.
that typically have less disposable income, although price sensitivity or elasticity
will vary by taxpayer. (12) [LO 3] Which is a more appropriate tax rate to use to compare taxpayers’ tax
burdens – the average or the effective tax rate? Why?
(10) [LO 3] Dontae stated that he didn’t want to earn any more money because it
would ―put him in a higher tax bracket.‖ What is wrong with Dontae’s Relative to the average tax rate, the effective tax rate provides a better depiction
reasoning? of a taxpayer‘s tax burden because it depicts the taxpayer‘s total tax paid as a
ratio of the sum of both taxable and nontaxable income earned.
Although earning additional taxable income may increase Dontae‘s marginal tax
rate (i.e., put him in a higher tax bracket), the additional income earned does not (13) [LO 3] Describe the differences between a proportional, progressive, and
affect the taxes that Dontae will pay on his existing income. Moving to a higher regressive tax rate structure.
tax bracket simply means that Dontae will pay a higher tax rate on the additional
income earned (not on the income that he already has). A proportional (flat) tax rate structure imposes a constant tax rate throughout the
tax base. In other words, as the tax base increases, the taxes paid increases, but
(11) [LO 3] Describe the three different tax rates discussed in the chapter and how the marginal tax rate remains constant. Because the marginal tax rate is constant
taxpayers might use them. across all levels of the tax base, the average tax rate remains constant across the
tax base and always equals the marginal tax rate. Common examples of
The marginal tax rate is the tax rate that applies to the taxpayer‘s additional proportional taxes include sales taxes and excise taxes (i.e., taxes based on
taxable income or deductions that the taxpayer is evaluating in a decision. quantity such as gallons of gas purchased).
Specifically,
A progressive tax rate structure imposes an increasing marginal tax rate as the
ΔTax (NewTotalTax OldTotalTax) tax base increases. In other words, as the tax base increases, both the marginal
Marginal Tax Rate tax rate and the taxes paid increase. Common examples of progressive tax rate
ΔTaxableIncome (NewTaxableIncome OldTaxableIncome)
structures include federal and most state income taxes and federal estate and gift
taxes.
The marginal tax rate is particularly useful in tax planning because it represents A regressive tax rate structure imposes a decreasing marginal tax rate as the tax
the rate of taxation or savings that would apply to additional taxable income or base increases. In other words, as the tax base increases, the taxes paid
tax deductions. increases, but the marginal tax rate decreases. Regressive tax rate structures are
not common. In the United States, the Social Security tax and the federal
The average tax rate represents the taxpayer‘s average level of taxation on each employment tax employ a regressive tax rate structure. However, there are other
dollar of taxable income. Specifically, regressive taxes when the tax is viewed in terms of effective tax rates. For
example, a sales tax by definition is a proportional tax – i.e., as taxable purchases
TotalTax increase, the sales tax rate (i.e., the marginal tax rate) remains constant.
Average Tax Rate =
TaxableIncome Nonetheless, when you consider that the proportion of your total income spent on
taxable purchases likely decreases as your total income increases, you can see the
The average tax rate is often used in budgeting tax expense as a portion of income sale tax as a regressive tax.
(i.e., what percent of taxable income earned is paid in tax).
(14) [LO 3] Arnold and Lilly recently had a discussion about whether a sales tax is a
The effective tax rate represents the taxpayer‘s average rate of taxation on each proportional tax or a regressive tax. Arnold argued that a sales tax is regressive.
dollar of total income (i.e., taxable and nontaxable income). Specifically, Lilly countered that the sales tax is a flat tax. Who was correct?
© McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC. © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.
3 4
, Solutions Manual—Taxation of Individuals, by Spilker et al. Solutions Manual—Taxation of Individuals, by Spilker et al.
Arnold and Lilly were both correct. A sales tax by definition is a proportional tax (19) [LO 4] What are some of the taxes that currently are unique to state and local
– i.e., as taxable purchases increase, the sales tax rate (i.e., the marginal tax rate) governments? What are some of the taxes that the federal, state, and local
remains constant. For this reason, Arnold was correct. Nonetheless, when you governments each utilize?
consider that the proportion of one‘s total income spent on taxable purchases
likely decreases as total income increases, the sales tax may be considered a The sales, use, and property (personal, real, intangible) taxes are unique to state
regressive tax. A good example of this is food. Although higher-income taxpayers and local governments. Taxes that are common among the federal, state, and
may pay more for food than lower-income taxpayers, higher-income taxpayers local governments include income taxes, excise taxes, and estate and gift taxes.
spend a smaller percentage of their income on food—this is why many states
exempt food from the sales tax base—because of its regressive nature. For this
(20) [LO 4] The state of Georgia recently increased its tax on a pack of cigarettes by
reason, Lilly was correct.
$2. What type of tax is this? Why might Georgia choose this type of tax?
(15) [LO 4] Which is the largest tax collected by the U.S. government? What types
of taxpayers are subject to this tax? The cigarette tax is both considered an excise tax (i.e., a tax based on quantity
purchased) and a ―sin‖ tax (i.e., a tax on goods that are deemed to be socially
The federal income tax is the largest tax collected by the U.S. government. undesirable). Georgia may choose this type of tax to discourage smoking and
Currently, federal income taxes are levied on individuals, corporations, estates, because sin taxes are often viewed as acceptable ways of increasing tax revenues.
and trusts.
(21) [LO 4] What is the difference between a sales tax and a use tax?
(16) [LO 4] What is the tax base for the Social Security and Medicare taxes for an
employee or employer? What is the tax base for Social Security and Medicare The tax base for sales taxes is retail sales of goods (and some services). The tax
taxes for a self-employed individual? Is the self-employment tax in addition to or base for the use tax is the retail price of goods owned, possessed or consumed
in lieu of federal income tax? within a state that were not purchased within the state (e.g., goods purchased
over the internet). The prevalence of the use tax has significantly declined since
Employee wages is the tax base for the Social Security and Medicare taxes. Net economic nexus for sales taxes was found to be constitutional (see State and
earnings from self-employment is the tax base for the self-employment tax. The Local Taxes chapter for a discussion).
self-employment tax is in addition to the federal income tax. The same is true for
employment taxes—they are in addition to the federal income tax. (22) [LO 4] What is an ad valorem tax? Name an example of this type of tax.
(17) [LO 4] What are unemployment taxes?
An ad valorem tax is a tax based on the fair market value of property. Real and
personal property taxes are examples of ad valorem taxes.
Employers are required to pay federal and state unemployment taxes, which fund
temporary unemployment benefits for individuals terminated from their jobs
without cause. The tax base for the unemployment taxes is wages or salary. (23) [LO 4] What are the differences between an explicit and an implicit tax?
(18) [LO 4] What is the distinguishing feature of an excise tax? An explicit tax is a tax that is directly imposed by a government unit and easily
quantified. Implicit taxes are the reduced rates of pretax return that a tax-favored
Excise taxes differ from other taxes in that the tax base on excise taxes is typically asset produces (e.g., the lower pretax rate of return earned by tax exempt
based on the quantity of an item or service purchased. The federal government municipal bonds). Although implicit taxes are real and equally important in
imposes a number of excise taxes on goods such as alcohol, diesel fuel, gasoline, understanding our tax system, they are difficult to quantify.
tobacco products and services such as telephone services. In addition, states also
often impose excise taxes on these same items. (24) [LO 4] When we calculate average and effective tax rates, do we consider
implicit taxes? What effect does this have on taxpayers’ perception of equity?
Implicit taxes are very difficult to quantify and thus, are generally not considered
when calculating average and effective tax rates. Since implicit taxes are ignored
in these calculations, taxpayers may conclude that groups of taxpayers investing
© McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC. © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.
5 6
, Solutions Manual—Taxation of Individuals, by Spilker et al. Solutions Manual—Taxation of Individuals, by Spilker et al.
in tax advantaged assets (subject to implicit tax) do not pay their fair share of tax (28) [LO 5] What is the difference between horizontal and vertical equity? How do
as represented by a low effective tax rate. tax preferences affect people’s view of horizontal equity?
(25) [LO 4] Benjamin recently bought a truck in Alabama for his business in Horizontal equity means that two taxpayers in similar situations pay the same tax.
Georgia. What different types of federal and state taxes may affect this Vertical equity is achieved when taxpayers with greater ability to pay tax, pay
transaction? more tax relative to taxpayers with a lesser ability to pay tax. One can view
vertical equity in terms of tax dollars paid or in terms of tax rates.
Benjamin will have to pay state sales tax in Alabama for the truck purchased.
However, some states only charge sales tax when the purchased vehicle is
registered. Assuming Alabama sales tax was charged, when the vehicle is Governmental units provide tax preferences for a variety of reasons – e.g.,
registered in Georgia, Benjamin will have to pay use tax on the purchase at a rate encourage investment, social objectives, etc. For example, a deduction for
representing any difference in the Alabama sales tax rate and the Georgia use tax mortgage interest paid which encourages home ownership. Whether one views
rate. Benjamin will also have to pay personal property tax annually on the truck. these tax preferences as appropriate or not, greatly influences whether one
Finally, since the vehicle is used in Benjamin‘s business, he will be able to considers a tax system to be fair in general and specifically, horizontally
depreciate the truck for federal income tax purposes. equitable. Specifically, if one views a tax preference as being inappropriate, this
would adversely affect one‘s view of horizontal equity.
(26) [LO 5] Kobe strongly dislikes SUVs and is appalled that so many are on the
road. He proposes to eliminate the federal income tax and replace it with a (29) [LO 3, LO 5] Montel argues that a flat income tax rate system is vertically
$50,000 annual tax per SUV. Based on the number of SUVs currently owned in equitable. Oprah argues that a progressive tax rate structure is vertically equitable.
the United States, he estimates the tax will generate exactly the amount of tax How do their arguments differ? Who is correct?
revenue currently collected from the income tax. What is wrong with Kobe’s
proposal? What type of forecasting is Kobe likely using? Vertical equity is achieved when taxpayers with greater ability to pay tax, pay
more tax relative to taxpayers with a lesser ability to pay tax. One can view
Kobe‘s forecast is based on static forecasting (i.e., he is ignoring how taxpayers vertical equity in terms of tax dollars paid or in terms of tax rates. Proponents of
may alter their activities in response to the tax law change). Given that taxpayers a flat income tax or sales tax (i.e., proportional tax rate structures) are more
are likely to substitute purchases of other vehicles for SUVs (i.e., the substitution likely to argue that vertical equity is achieved when taxpayers with a greater
effect), Kobe‘s proposal is likely to result in a large discrepancy in projected and ability to pay tax, pay more in tax dollars. Proponents of a progressive tax
actual tax revenues since taxpayers will likely purchase fewer SUVs that are system are more likely to argue that taxpayers with a greater ability to pay should
subject to the tax. be subject to a higher tax rate. This view is based upon the argument that the
relative burden of a flat tax rate decreases as a taxpayer‘s income (e.g.,
(27) [LO 5] What is the difference between the income and substitution effects? For disposable income) increases. Which is the correct answer? There is no correct
which types of taxpayers is the income effect more likely descriptive? For which answer. Nonetheless, many feel very strongly regarding one view or the other.
types of taxpayers is the substitution effect more likely descriptive?
The income effect predicts that when taxpayers are taxed more (e.g., tax rate (30) [LO 3, LO 5] Discuss why evaluating vertical equity simply based on tax rate
increases from 22 to 24 percent), they will work harder to generate the same structure may be less than optimal.
after-tax dollars. The substitution effect predicts that when taxpayers are taxed
more, they will substitute nontaxable activities (e.g., leisure activities) for taxable Although tax rate structures can be used, in part, to assess vertical equity,
activities because the marginal value of taxable activities has decreased. The focusing on the tax rate structure solely ignores the role that the tax base plays in
income effect is likely to be more descriptive for taxpayers with insufficient determining vertical equity. Indeed, focusing on the tax rate structure in
income to meet their necessities, etc. for their desired standard of living. The evaluating a tax system is appropriate only if the tax base chosen (e.g., taxable
substitution effect is likely to be more descriptive for taxpayers with sufficient income, purchases, property owned, etc.) accurately portrays a taxpayer‘s ability
income to meet their necessities and to sustain their desired standard of living. to pay. This can be a rather strong assumption. Consider the sales tax. Although
taxable purchases typically increase as taxpayers‘ total incomes increase, total
incomes typically increase at a much faster rate than taxable purchases. Thus, the
gap between taxable purchases and total income widens as total income
© McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC. © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.
7 8
based upon their tax rhetoric. Likewise, the major political parties generally have
Solution Manual For very diverse views of the appropriate way to tax the public. Determining who is
McGraw-Hill's Taxation of Individuals 2024 Edition, taxed, what is taxed, and how much is taxed are difficult questions. Voters must
15th Edition Spilker have a basic understanding of taxes to evaluate the merits of alternative tax
proposals offered by opposing political candidates and their political parties.
Chapter 1-14
(4) [LO 2] Courtney recently received a speeding ticket on her way to the university.
Chapter 1 Her fine was $200. Is this considered a tax? Why or why not?
An Introduction to Tax
The $200 speeding ticket is not considered a tax. Instead, it is considered a fine
or penalty. Taxes differ from fines and penalties because taxes are not intended
Discussion Questions to punish or prevent illegal behavior.
(1) [LO 1] Jessica’s friend Zachary once stated that he couldn’t understand why (5) [LO 2] Marlon and Latoya recently started building a house. They had to pay
someone would take a tax course. Why is this a rather naïve view? $300 to the county government for a building permit. Is the $300 payment a tax?
Why or why not?
Taxes are a part of everyday life and have a financial effect on many of the major
personal decisions that individuals face (e.g., investment decisions, evaluating The building permit is not considered a tax because $300 payment is directly
alternative job offers, saving for education expenses, gift or estate planning, etc.). linked to a benefit that they received (i.e., the ability to build a house).
(2) [LO 1] What are some aspects of business that require knowledge of taxation? (6) [LO 2] To help pay for the city’s new stadium, the city of Birmingham recently
What are some aspects of personal finance that require knowledge of taxation? enacted a 1 percent surcharge on hotel rooms. Is this a tax? Why or why not?
Taxes play an important role in fundamental business decisions such as the The 1 percent surcharge is a tax. The 1 percent surcharge is an earmarked tax –
following: i.e., collected for a specific purpose. The surcharge is considered a tax because
the tax payments made by taxpayers do not directly relate to the specific benefit
What organizational form should a business use?
received by the taxpayers.
Where should the business locate?
How should business acquisitions be structured? (7) [LO 2] As noted in Example 1-2, tolls, parking meter fees, and annual licensing
How should the business compensate employees? fees are not considered taxes. Can you identify other fees that are similar?
What is the appropriate mix of debt and equity for the business?
Should the business rent or own its equipment and property? There are several possible answers to this question. Some common examples
How should the business distribute profits to its owners? include entrance fees to national parks, tag fees paid to local/state government
One must consider all transaction costs (including taxes) to evaluate the merits of for automobiles, boats, etc.
a transaction.
(8) [LO 2] If the general objective of our tax system is to raise revenue, why does the
Common personal financial decisions that taxes influence include: choosing income tax allow deductions for charitable contributions and retirement plan
investments, retirement planning, choosing to rent or buy a home, evaluating contributions?
alternative job offers, saving for education expenses, and doing gift or estate
planning. In addition to the general objective of raising revenue, Congress uses the federal
tax system to encourage certain behavior and discourage other behavior. The
charitable contribution deduction is intended to encourage taxpayers to support
(3) [LO 1] Describe some ways in which taxes affect the political process in the the initiatives of charitable organizations, whereas deductions for retirement
United States. contributions are intended to encourage retirement savings. Another objective of
the tax system is to redistribute wealth.
U.S. presidential candidates often distinguish themselves from their opponents
© McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC. © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.
1 2
, Solutions Manual—Taxation of Individuals, by Spilker et al. Solutions Manual—Taxation of Individuals, by Spilker et al.
(9) [LO 2] One common argument for imposing so-called sin taxes is the social goal Effective Tax Rate =
Total Tax
of reducing demand for such products. Using cigarettes as an example, is there a Total Income
segment of the population that might be sensitive to price and for whom high
taxes might discourage purchases? The effective tax rate provides a depiction of a taxpayer‘s tax burden because it
depicts the taxpayer‘s total tax paid as a ratio of the sum of both taxable and
The most obvious segment sensitive to price may be teenagers and younger adults nontaxable income earned.
that typically have less disposable income, although price sensitivity or elasticity
will vary by taxpayer. (12) [LO 3] Which is a more appropriate tax rate to use to compare taxpayers’ tax
burdens – the average or the effective tax rate? Why?
(10) [LO 3] Dontae stated that he didn’t want to earn any more money because it
would ―put him in a higher tax bracket.‖ What is wrong with Dontae’s Relative to the average tax rate, the effective tax rate provides a better depiction
reasoning? of a taxpayer‘s tax burden because it depicts the taxpayer‘s total tax paid as a
ratio of the sum of both taxable and nontaxable income earned.
Although earning additional taxable income may increase Dontae‘s marginal tax
rate (i.e., put him in a higher tax bracket), the additional income earned does not (13) [LO 3] Describe the differences between a proportional, progressive, and
affect the taxes that Dontae will pay on his existing income. Moving to a higher regressive tax rate structure.
tax bracket simply means that Dontae will pay a higher tax rate on the additional
income earned (not on the income that he already has). A proportional (flat) tax rate structure imposes a constant tax rate throughout the
tax base. In other words, as the tax base increases, the taxes paid increases, but
(11) [LO 3] Describe the three different tax rates discussed in the chapter and how the marginal tax rate remains constant. Because the marginal tax rate is constant
taxpayers might use them. across all levels of the tax base, the average tax rate remains constant across the
tax base and always equals the marginal tax rate. Common examples of
The marginal tax rate is the tax rate that applies to the taxpayer‘s additional proportional taxes include sales taxes and excise taxes (i.e., taxes based on
taxable income or deductions that the taxpayer is evaluating in a decision. quantity such as gallons of gas purchased).
Specifically,
A progressive tax rate structure imposes an increasing marginal tax rate as the
ΔTax (NewTotalTax OldTotalTax) tax base increases. In other words, as the tax base increases, both the marginal
Marginal Tax Rate tax rate and the taxes paid increase. Common examples of progressive tax rate
ΔTaxableIncome (NewTaxableIncome OldTaxableIncome)
structures include federal and most state income taxes and federal estate and gift
taxes.
The marginal tax rate is particularly useful in tax planning because it represents A regressive tax rate structure imposes a decreasing marginal tax rate as the tax
the rate of taxation or savings that would apply to additional taxable income or base increases. In other words, as the tax base increases, the taxes paid
tax deductions. increases, but the marginal tax rate decreases. Regressive tax rate structures are
not common. In the United States, the Social Security tax and the federal
The average tax rate represents the taxpayer‘s average level of taxation on each employment tax employ a regressive tax rate structure. However, there are other
dollar of taxable income. Specifically, regressive taxes when the tax is viewed in terms of effective tax rates. For
example, a sales tax by definition is a proportional tax – i.e., as taxable purchases
TotalTax increase, the sales tax rate (i.e., the marginal tax rate) remains constant.
Average Tax Rate =
TaxableIncome Nonetheless, when you consider that the proportion of your total income spent on
taxable purchases likely decreases as your total income increases, you can see the
The average tax rate is often used in budgeting tax expense as a portion of income sale tax as a regressive tax.
(i.e., what percent of taxable income earned is paid in tax).
(14) [LO 3] Arnold and Lilly recently had a discussion about whether a sales tax is a
The effective tax rate represents the taxpayer‘s average rate of taxation on each proportional tax or a regressive tax. Arnold argued that a sales tax is regressive.
dollar of total income (i.e., taxable and nontaxable income). Specifically, Lilly countered that the sales tax is a flat tax. Who was correct?
© McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC. © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.
3 4
, Solutions Manual—Taxation of Individuals, by Spilker et al. Solutions Manual—Taxation of Individuals, by Spilker et al.
Arnold and Lilly were both correct. A sales tax by definition is a proportional tax (19) [LO 4] What are some of the taxes that currently are unique to state and local
– i.e., as taxable purchases increase, the sales tax rate (i.e., the marginal tax rate) governments? What are some of the taxes that the federal, state, and local
remains constant. For this reason, Arnold was correct. Nonetheless, when you governments each utilize?
consider that the proportion of one‘s total income spent on taxable purchases
likely decreases as total income increases, the sales tax may be considered a The sales, use, and property (personal, real, intangible) taxes are unique to state
regressive tax. A good example of this is food. Although higher-income taxpayers and local governments. Taxes that are common among the federal, state, and
may pay more for food than lower-income taxpayers, higher-income taxpayers local governments include income taxes, excise taxes, and estate and gift taxes.
spend a smaller percentage of their income on food—this is why many states
exempt food from the sales tax base—because of its regressive nature. For this
(20) [LO 4] The state of Georgia recently increased its tax on a pack of cigarettes by
reason, Lilly was correct.
$2. What type of tax is this? Why might Georgia choose this type of tax?
(15) [LO 4] Which is the largest tax collected by the U.S. government? What types
of taxpayers are subject to this tax? The cigarette tax is both considered an excise tax (i.e., a tax based on quantity
purchased) and a ―sin‖ tax (i.e., a tax on goods that are deemed to be socially
The federal income tax is the largest tax collected by the U.S. government. undesirable). Georgia may choose this type of tax to discourage smoking and
Currently, federal income taxes are levied on individuals, corporations, estates, because sin taxes are often viewed as acceptable ways of increasing tax revenues.
and trusts.
(21) [LO 4] What is the difference between a sales tax and a use tax?
(16) [LO 4] What is the tax base for the Social Security and Medicare taxes for an
employee or employer? What is the tax base for Social Security and Medicare The tax base for sales taxes is retail sales of goods (and some services). The tax
taxes for a self-employed individual? Is the self-employment tax in addition to or base for the use tax is the retail price of goods owned, possessed or consumed
in lieu of federal income tax? within a state that were not purchased within the state (e.g., goods purchased
over the internet). The prevalence of the use tax has significantly declined since
Employee wages is the tax base for the Social Security and Medicare taxes. Net economic nexus for sales taxes was found to be constitutional (see State and
earnings from self-employment is the tax base for the self-employment tax. The Local Taxes chapter for a discussion).
self-employment tax is in addition to the federal income tax. The same is true for
employment taxes—they are in addition to the federal income tax. (22) [LO 4] What is an ad valorem tax? Name an example of this type of tax.
(17) [LO 4] What are unemployment taxes?
An ad valorem tax is a tax based on the fair market value of property. Real and
personal property taxes are examples of ad valorem taxes.
Employers are required to pay federal and state unemployment taxes, which fund
temporary unemployment benefits for individuals terminated from their jobs
without cause. The tax base for the unemployment taxes is wages or salary. (23) [LO 4] What are the differences between an explicit and an implicit tax?
(18) [LO 4] What is the distinguishing feature of an excise tax? An explicit tax is a tax that is directly imposed by a government unit and easily
quantified. Implicit taxes are the reduced rates of pretax return that a tax-favored
Excise taxes differ from other taxes in that the tax base on excise taxes is typically asset produces (e.g., the lower pretax rate of return earned by tax exempt
based on the quantity of an item or service purchased. The federal government municipal bonds). Although implicit taxes are real and equally important in
imposes a number of excise taxes on goods such as alcohol, diesel fuel, gasoline, understanding our tax system, they are difficult to quantify.
tobacco products and services such as telephone services. In addition, states also
often impose excise taxes on these same items. (24) [LO 4] When we calculate average and effective tax rates, do we consider
implicit taxes? What effect does this have on taxpayers’ perception of equity?
Implicit taxes are very difficult to quantify and thus, are generally not considered
when calculating average and effective tax rates. Since implicit taxes are ignored
in these calculations, taxpayers may conclude that groups of taxpayers investing
© McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC. © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.
5 6
, Solutions Manual—Taxation of Individuals, by Spilker et al. Solutions Manual—Taxation of Individuals, by Spilker et al.
in tax advantaged assets (subject to implicit tax) do not pay their fair share of tax (28) [LO 5] What is the difference between horizontal and vertical equity? How do
as represented by a low effective tax rate. tax preferences affect people’s view of horizontal equity?
(25) [LO 4] Benjamin recently bought a truck in Alabama for his business in Horizontal equity means that two taxpayers in similar situations pay the same tax.
Georgia. What different types of federal and state taxes may affect this Vertical equity is achieved when taxpayers with greater ability to pay tax, pay
transaction? more tax relative to taxpayers with a lesser ability to pay tax. One can view
vertical equity in terms of tax dollars paid or in terms of tax rates.
Benjamin will have to pay state sales tax in Alabama for the truck purchased.
However, some states only charge sales tax when the purchased vehicle is
registered. Assuming Alabama sales tax was charged, when the vehicle is Governmental units provide tax preferences for a variety of reasons – e.g.,
registered in Georgia, Benjamin will have to pay use tax on the purchase at a rate encourage investment, social objectives, etc. For example, a deduction for
representing any difference in the Alabama sales tax rate and the Georgia use tax mortgage interest paid which encourages home ownership. Whether one views
rate. Benjamin will also have to pay personal property tax annually on the truck. these tax preferences as appropriate or not, greatly influences whether one
Finally, since the vehicle is used in Benjamin‘s business, he will be able to considers a tax system to be fair in general and specifically, horizontally
depreciate the truck for federal income tax purposes. equitable. Specifically, if one views a tax preference as being inappropriate, this
would adversely affect one‘s view of horizontal equity.
(26) [LO 5] Kobe strongly dislikes SUVs and is appalled that so many are on the
road. He proposes to eliminate the federal income tax and replace it with a (29) [LO 3, LO 5] Montel argues that a flat income tax rate system is vertically
$50,000 annual tax per SUV. Based on the number of SUVs currently owned in equitable. Oprah argues that a progressive tax rate structure is vertically equitable.
the United States, he estimates the tax will generate exactly the amount of tax How do their arguments differ? Who is correct?
revenue currently collected from the income tax. What is wrong with Kobe’s
proposal? What type of forecasting is Kobe likely using? Vertical equity is achieved when taxpayers with greater ability to pay tax, pay
more tax relative to taxpayers with a lesser ability to pay tax. One can view
Kobe‘s forecast is based on static forecasting (i.e., he is ignoring how taxpayers vertical equity in terms of tax dollars paid or in terms of tax rates. Proponents of
may alter their activities in response to the tax law change). Given that taxpayers a flat income tax or sales tax (i.e., proportional tax rate structures) are more
are likely to substitute purchases of other vehicles for SUVs (i.e., the substitution likely to argue that vertical equity is achieved when taxpayers with a greater
effect), Kobe‘s proposal is likely to result in a large discrepancy in projected and ability to pay tax, pay more in tax dollars. Proponents of a progressive tax
actual tax revenues since taxpayers will likely purchase fewer SUVs that are system are more likely to argue that taxpayers with a greater ability to pay should
subject to the tax. be subject to a higher tax rate. This view is based upon the argument that the
relative burden of a flat tax rate decreases as a taxpayer‘s income (e.g.,
(27) [LO 5] What is the difference between the income and substitution effects? For disposable income) increases. Which is the correct answer? There is no correct
which types of taxpayers is the income effect more likely descriptive? For which answer. Nonetheless, many feel very strongly regarding one view or the other.
types of taxpayers is the substitution effect more likely descriptive?
The income effect predicts that when taxpayers are taxed more (e.g., tax rate (30) [LO 3, LO 5] Discuss why evaluating vertical equity simply based on tax rate
increases from 22 to 24 percent), they will work harder to generate the same structure may be less than optimal.
after-tax dollars. The substitution effect predicts that when taxpayers are taxed
more, they will substitute nontaxable activities (e.g., leisure activities) for taxable Although tax rate structures can be used, in part, to assess vertical equity,
activities because the marginal value of taxable activities has decreased. The focusing on the tax rate structure solely ignores the role that the tax base plays in
income effect is likely to be more descriptive for taxpayers with insufficient determining vertical equity. Indeed, focusing on the tax rate structure in
income to meet their necessities, etc. for their desired standard of living. The evaluating a tax system is appropriate only if the tax base chosen (e.g., taxable
substitution effect is likely to be more descriptive for taxpayers with sufficient income, purchases, property owned, etc.) accurately portrays a taxpayer‘s ability
income to meet their necessities and to sustain their desired standard of living. to pay. This can be a rather strong assumption. Consider the sales tax. Although
taxable purchases typically increase as taxpayers‘ total incomes increase, total
incomes typically increase at a much faster rate than taxable purchases. Thus, the
gap between taxable purchases and total income widens as total income
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