The government modifies consumption tax somewhat so that

Reference no: EM13388173

The lecture described how taxing income may change savings behavior. Suppose instead that the government taxed consumption.

To be specific, suppose we have a two-period model. An individual earns labor income Y0 =$100k at time zero, and earns no labor income at time 1. The individual may consume or save that income. Savings grow at rate r=.03. For every dollar of consumption, the individual pays the tax rate τ=.30 to the government.

a. Graph the two-period budget constraint for consumption. What is the slope? Is this tax distortionary?

b. The government modifies the consumption tax somewhat so that the first $20k of consumption in each period is tax free. Now graph the budget constraint.

Reference no: EM13388173

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