Suppose the government of Washington is considering the addition of a new tax on

Question

Suppose the government of Washington is considering the addition of a new tax on rms. You

have been called in to provide expert analysis on how such a tax would eect employment of

labor. There are 3 proposals the government is considering:

1. A tax on every hour an employee works (e.g., X" cents per hour).

2. A tax on some percentage of the value of the rm's buildings, land, and machinery (e.g.,

Y" percent of the total property value).

3. A tax on every unit of output a rm produces (e.g., Z" cents per unit of output).

While all the plans have the potential to reduce employment opportunities, which plan would

probably have the most favorable impact on employment of labor? Brie y explain your reason-

ing.

Explanation / Answer

Plan 2 will have the most favorable impact on employment of labor in all probabilities (From firm's viewpoint).

Plan 1 will directly hamper labor employment since a tax is imposed on every labor hour worked. This will increase the cost of labor & will increase the product cost. If firm passes on the cost increase to consumers, demand will fall, ceteris paribus. So labor employment will also decrease.

Plan 3 will directly introduce a disincentive of production of output by employing more labor, since each additional output produced will increase the tax burden directly, with the output tax. As tax on output is imposed, firm will pass on the increased cost to the consumers in form of increased price, which will decrease demand. So, producing more output is discouraged with this taxation model.

Plan 2 will minimize the impact of tax on labor employment, since the book value of property will keep decreasing over time (Depreciation effect) and hence, as time passes, the tax burden will keep decreasing. This will gradually encourage firm to increase output and therefore, to employ more labor.

Note: Labor supply, however, will be directly affected by Plan 1 instead, since workers will receive less net wage per hour worked. The reduced net wage will discourage them from working more hours.

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