(10 points) The lecture described how taxing income may change savings behavior.

Question

(10 points) 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 =.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.

Explanation / Answer

if the tax rate is 30% and savings grow rate is 30%, the remaining can i assume personal consumption?

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