Problem Set 6 Answers - ECON 454, Fall 2007 Department of...

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ECON 454, Fall 2007 Department of Economics, University of Maryland Jessica Hennessey Problem Set #6 Question 1 For which group of workers is the substitution e/ect associated with a tax increase more likely to outweigh the income e/ect: primary earners or secondary earners? Explain. A tax increase will reduce income, and through the income e/ect reduce the demand for leisure. Workers will respond by working more. The substitution e/ect works in the opposite direction: as income taxes increase, the relative price of leisure falls, so workers will tend to consume more leisure and work fewer hours. The empirical evidence suggests small elasticities of labor supply for primary earners and larger elasticities of labor supply for secondary earners. This suggests that the substitution e/ect outweighs the income e/ect for secondary earners but not for primary earners. This is reasonable, too, since secondary earners face a larger primary earner already provides substantial income for the household, so secondary income is less essential for many households. Question 2 Why does the Earned Income Tax Credit exacerbate the marriage penalty for low-income workers? Suggest an alternative method of calculating the EITC that reduces this penalty. The EITC exacerbates the marriage penalty by combining both spouses²incomes to determine eligibility for the credit. Two fairly low incomes can combine to equal a total family income high enough to place the
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Problem Set 6 Answers - ECON 454, Fall 2007 Department of...

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