Question

Suppose a country currently has a tax system that gives each citizen $5,000 in cash up front regardless of their income. if they work, the first $10,000 in earned income is not taxed at all. all earned income over $10,000 at a 25% rate. policymakers are considering replacing this system: the proposed new system would drop the $5,000 cash giveaway and instead would subsidize the first $10,000 in earned income at a 50% rate. all income earned over $10,000 still would be taxed at the same 25% rate. describe the effects of this policy change on the labor supply of workers with various incomes.

in particular, how will the policy change affect the decision of whether or not to work?

Answer 1

The policy change from a guaranteed cash subsidy to a wage subsidy can encourage low-income workers to work more but may lead higher-income workers to work less, as their disposable income might decrease. The decision to work will be influenced by how the subsidy affects their effective wage and disposable income.

Step-by-step explanation:

The policy change from a guaranteed $5,000 cash subsidy to a 50% subsidy for the first $10,000 earned would affect the labor supply differently for workers of various income levels.

For low-income workers who might work part-time or consider entering the workforce, the new subsidy could act as an incentive to work since their effective hourly wage would increase. However, for higher-income workers who are already earning well above $10,000, the removal of the flat $5,000 could potentially reduce their disposable income, depending on how much they value the leisure time that the cash provided.

The policy change may result in these individuals choosing to work less. Furthermore, the decision of whether or not to work under the new system may be more attractive to those not currently working, as their earnings would be effectively doubled on the first $10,000, instead of receiving a flat sum without the need to work.

Overall, while tax cuts may encourage some groups to work more hours, the effect is not uniform across all income levels. Tax policy considerations must take into account these varying responses to ensure that objectives, such as reducing poverty or encouraging labor participation, are met without adversely affecting certain groups.