Discuss the exact effect on wages of the payroll tax

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Question: By U.S. law, your employer pays half of the payroll tax and you, the worker, pay the other half. We mentioned that according to the basics of supply and demand, the part of the tax paid by the employer is likely to cut the worker's take-home pay. Let's see why. We'll start off in a land without any payroll taxes and then see how adding payroll taxes (like FICA and Medicare) affects the worker's take-home pay.

a. Who is it that "supplies labor"? Is it workers or firms? And who demands labor? Workers or firms?

b. The following chart illustrates the pretax equilibrium. Mark the equilibrium wage and quantity of labor in this market. In part c, remember that this "wage" is the amount paid directly to workers.

c. Suppose the government enacts a new payroll tax of 10% of worker wages, "paid" fully by employers. What will happen to the typical firm's demand for labor? In other words, when firms learn that every time they hire a worker, they have to pay not only that worker's wage but also 10% of that worker's wage to the government, will that increase or decrease their willingness to hire workers? After you answer in words, also illustrate the shift in the graph.

d. So, in the equilibrium with a new fully employer-paid payroll tax, will worker's take-home wages be higher or lower than beforehand?

e. Imagine that most workers want full-time jobs to support their families whether the wage is high or low. What does this imply about the shape of the supply curve? Redo the analysis with the new supply curve and discuss the exact effect on wages of the payroll tax.

Reference no: EM131834633

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