The present tax system has two parts. The first part subsidizes
workers’ wages. The government pays each worker $2 per hour extra
for each hour that they work in a week in the labor market up to a
maximum payment of $40 per week. The second part is a tax on labor
earnings. A 20% tax is placed on labor earnings above $400 per week
(the government subsidy is not counted as earnings in this
calculation). For this question, assume that leisure is a normal
good for all workers.
a) Boris works at a job that pays $10 per hour. He has no
non-labor income. He can work at most 60 hours per week and the
price of food is $1 per unit. Assuming that he consumes only food
and leisure, graph Boris’s budget constraint under the present tax
system. If Boris works 50 hours per week, how much food does he
b) Congress is considering a change to the tax system. A bill
has been put forward to eliminate both the subsidy and tax. That
is, if the law passes the government will play no role in the labor
market. On your graph from part a), graph how this bill would
change Boris’ budget constraint. What is your prediction for how
this change would affect his hour of work?
c) How would your prediction of how Boris would change his hours
of work after the tax change differ if he was originally working 30
hours per week? 10 hours per week?