Suppose as in the federal income tax code

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Suppose as in the federal income tax code for the United States, that the representative consumer faces a wage income tax with a standard deduction. That is, the representative consumer pays no tax on wage income for the first x units of real wage income, and then pays a proportional tax t on each unit of real wage income greater than x. Now the government reduces the tax deduction x.

a. Using diagrams, determine the effects of this tax change on the individual's consumption/leisure choices. Explain your results in terms of substitution and income effects. Make sure you consider two cases. In the first case the consumer does not pay any tax before x is reduced, and in the second case the consumer pays a positive tax before x is reduced.

b. What effect will the increase in x have on aggregate employment, output and real wages?

Reference no: EM13736670

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