Analyze the impact of each type of tax on savings

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Reference no: EM13212162

The government is considering two alternative types of taxes. The first is a tax on interest income, the second is a tax on labour income. Both are to be imposed at rate t (i.e., t=.20, or 20%). Your job is to help the government understand the impact of these two taxes on savings decisions. To do so, consider the consumption/savings model we discussed in class where preferences are defined over "consumption when young" (CY) and "consumption when old" (CO), labour income is fixed an earned in the "young" period, and the (before tax) interest rate on savings is r.

a. Write down the intertemporal budget constraint for three situations:
i. There is no tax.
ii. A tax on labour income is imposed at rate t.
iii. The tax on interest income is imposed.

b. In two separate diagrams, analyze the impact of each type of tax on savings. Will savings be expected to rise or fall in each case? Explain (where appropriate invoke a discussion of income and substitution effects).

Reference no: EM13212162

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