1.) Suppose that the government adopts a lump-sum tax system under which the tot
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Question
1.) Suppose that the government adopts a lump-sum tax system under which the total tax amount is T. Further suppose that the governemnt decreases tax amount. What are the effects of a decrease in T on consumer’s optimal consumption (c) and leisure (l)? Explain why.
2) Suppose that the government replaces a lump-sum tax system with a proportinal labor income tax system. That is, the government imposes a proportional tax on the representative consumer’s labor income, whose tax rate is t. Further suppose that the government decreases the proportional income tax rate. What are the effects of a decrease in t on c and l? Explain why.
Explanation / Answer
The imposition of a lump sum tax will mean that total disposable income will fall on a total basis but this will have no impact on the trade off between income and leisure and so the labour lesiure schedule will shift downwards as the tax is imposed. The consumption level will thus fall. The slope of the labour leisure schedule will however not be affected. A labour income tax will however tax income on a per unit basis and this will mean that more leisure is chosen in place of greater consumption. This is a per unit tax and impacts consumption and leisure and so the slope is effected of the schedule.
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