Chap016 - Chapter 16 Personal Taxation and Behavior Chapter...

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Chapter 16 – Personal Taxation and Behavior Chapter 16 – Personal Taxation and Behavior 1. The supply of labor (and other factors) in and out of a state is more elastic than the supply of factors to the nation as a whole. Therefore, an income tax reduction at the state level is likely to lose less revenue than such a reduction at the federal level, ceteris paribus. Just as one can think of “welfare-induced” migration for poor households, one can think of “tax-induced” migration for businesses and possibly workers. If the state lowers tax rates ( and other states do not respond accordingly) , then one imagines that a number of businesses will enter that state and spur economic activity. 2. If individuals view their loss in the labor income taxes as offset by the benefits of public services, labor supply falls by AB hours. This is the compensated change in hours with respect to a change in the net wage rate. 3. 61
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Part 4 – The United States Revenue System 4. The effect of the change in the highest marginal tax rate on the individual’s budget constraint is demonstrated below: Income Leisure The resulting change in the tax rate moves part of the budget line out to the new, dotted budget constraint. This policy has an effect on labor supply analogous to the effect of an increase in an individual’s wage rate on labor supply: it is theoretically ambiguous. The reason for this ambiguity is that there are two competing effects -- a substitution effect which acts to decrease leisure, and an income effect which increases leisure. The decrease in the tax rate makes leisure more expensive, so the substitution effect dictates that less of it is to be consumed. However, there is extra income provided by this tax cut, and the income effect makes the individual want to consume more leisure. These two competing effects make the overall change in labor supply ambiguous. Existing empirical work suggests that for prime age males, the income and substitution effects more or less cancel each other out. For working wives, the substitution effect dominates, meaning that the reduction in marginal tax rates would tend to increase their labor supply. The effect on savings can be demonstrated using a diagram illustrating the change in the
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This note was uploaded on 12/18/2010 for the course ECON 2003 taught by Professor Tong during the Fall '10 term at Uni. Southampton.

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Chap016 - Chapter 16 Personal Taxation and Behavior Chapter...

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