Suppose that a nation has implemented a system for applying a tax rate of 2 percent to the incomes earned by the 10 percent of its residents with the highest income. All funds collected are then transferred directly to the 10 percent of the nation's residents with the lowest incomes.
a)What is the general effect on the shape of a lorenz curve based on pretax incomes?
b)What is the general effect on the shape of lorenz curve based on after-tax incomes?
a) In order to determine the general effect on the shape of a Lorenz curve based on pretax incomes, we should first understand what a Lorenz curve represents.
The Lorenz curve is a graphical representation of income inequality within a population. It plots the cumulative percentage of total income earned by the corresponding cumulative percentage of the population, starting with the lowest income earners.
In this scenario, the implementation of a tax rate of 2 percent on the top 10 percent of residents with the highest incomes means that a portion of their income will be redistributed to the lowest 10 percent of residents. This redistribution aims to reduce income inequality within the nation.
The general effect on the shape of the Lorenz curve based on pretax incomes will likely be a shift towards greater equality. This means that the curve will shift towards the line of equality, representing a more equal distribution of income within the population.
b) Moving on to the general effect on the shape of the Lorenz curve based on after-tax incomes, we need to consider the impact of the tax rate on income redistribution.
Implementing a tax rate of 2 percent on the top 10 percent of residents' incomes effectively reduces their after-tax incomes. This reduction in income among the higher earners will likely contribute to a more equal distribution of income within the population, as the redistributed funds are transferred to the lowest 10 percent of residents.
As a result, the general effect on the shape of the Lorenz curve based on after-tax incomes will likely be a further shift towards greater equality. The curve will move even closer to the line of equality, reflecting the reduced income inequality brought about by the tax and redistribution system.
It is important to note that the actual impact on the Lorenz curve's shape will depend on various factors, such as the initial income distribution, the extent of the tax rate, and the efficiency of the redistribution mechanism.