1) Assume that you live in a state that applies a 5 percent retail sales tax to many items. The
governor is concerned about the impact of sales taxes on low income households and has asked
you to evaluate two different proposals:1
–exemption of food from the sales tax base;
–a tax rebate of $300 per person for low income households (this could be set up as a
credit on the state income tax). A tax credit is subtracted directly from taxes.
The governor has asked you to evaluate these two proposals using the following information on
typical households;

Income
Family size
Taxable purchases (including
food)
Purchases of food

Low/Middle-Income Family
(LMI)
$27,500
3
18,000

Middle/Upper-Income Family
(MUI)
$80,000
4
45,000

11,000

27,000

a) Calculate the sales taxes paid by each family and the “effective tax rate” (total taxes
divided by income) for the following three cases;
–without any changes in the tax-base
–with the exemption of food
–with the tax credit of $300 per person.
Which would you select on equity grounds? Explain.
b) If we assume for simplicity that 80% of households are LMI and 20% are MUI, then
these tax plans will raise similar amount of revenue. (You can confirm this.) Based on
this assumption, evaluate them on the other criteria. Based on your evaluation of all
criteria, which would you recommend?
Please use Excel to do these problems. Do all calculations in Excel so that I can see the formulas you
use to answer each question.
2) Comparing the effects of three changes to the property tax:
Assume that the mayor of your city is concerned about the property tax burden on low-income
households. She has asked you to analyze three proposals:
1

This problem is adapted from problem 3 in Chapter 9 of John Mikesell. 2003. Fiscal Administration. (New York:
Wadsworth Publishers).

(1) Homestead exemption of $10,000 on assessed value of owner-occupied residential
property.
(2) Comprehensive reassessment of all property to so that estimated market value
equals actual market value; and
(3) A circuit breaker, which is a credit for high property tax burdens on the state income
tax. The circuit breaker credit (CB) is equal to (PT – b*I), where PT is property
taxes, I is income, b is the share of income considered to be a high property tax
burden. When actual property taxes (PT) exceed the acceptable property tax burden
(bI), the difference is the income tax credit; if bI > PT, then the credit is set equal to
zero. For renters, their property taxes are assumed to be 10% of income. The
property tax burden parameter (b) is equal to 7% if income is below $20,000, 8% if
income is $20,000 and $30,000, 9% if income is between $30,000 and $40,000, and
10% for incomes above $40,000.
She has asked you to compare the impact on three typical households:
Low-Income
Renter*

Low-Income
Homeowner

$15,000

$15,000

$50,000

Actual Market Value
of Property
$60,000

$60,000

$150,000

Estimated Market
Property Value

$60,000

$60,000

$100,000

Assessed Value
of Property

$30,000

$30,000

$50,000

Total
Income

Upper-Middle
Inc. Homeowner

* The market value of an apartment is what it would sell for as a condominium.
The other pertinent information for your analysis includes:
– all households have 4 persons
-nominal property tax rate: 5% of assessed value
-official assessment ratio: 50%
-assume all property taxes on rental property are passed onto the renter
-The state has a flat income tax with a rate of 8% on all taxable income. For simplicity,
you can assume that taxable income equals total income.
Using this information answer the following questions. Show your work in Excel!!
a) Calculate the property taxes paid by each household and the two types of “effective tax
rates” (total taxes divided by income, and total taxes divided by market value) for the
following three cases:

(a) without the homestead exemption or reassessment;
(b) with the homestead exemption of $10,000;
(c)with reassessment of property. You can assume reassessment means that all
estimated market values are brought up to actual market value. The assessed
values will adjust to keep the official assessment ratio equal to 50%.
(d) with the circuit breaker.
Compare the impact of these two proposals on horizontal and vertical equity relative to
the present system.
b) If you assume that tax rates can be adjusted so that these two proposals raise the same
revenue, evaluate them on the other criteria. Based on your evaluation of all criteria,
which would you recommend?
Please use Excel to do these problems. Do all calculations in Excel so that I can see the formulas you
use to answer each question.