Public Economics: Taxation

1. Personal Income Tax Reforms

Examine the following proposed tax reforms. Evaluate them according to the following three principles for optimal taxation: equity, efficiency, and complexity considerations.

(a) Introduce a new non-refundable tax credit for energy-efficient refrigerators.

(b) Eliminate the itemized deduction for charitable giving.

2. Hillary's New Job

Consider the case of Hillary, who is eligible for public assistance benefits of $400 per week when she does not work. For every dollar that she earns, her benefits are reduced by $1 (until there are no benefits left). Hillary has been offered a new job that pays $20 per hour, and at which she is entitled to work as much as she chooses (up to 40 hours/week). She has no other source of income and faces no other taxes.

(a) Please draw Hillary's weekly budget constraint in a consumption/leisure diagram. Indicate the slopes of the segments of the budget constraint. How many hours must Hillary work before she earns more in wages than she loses in foregone public assistance benefits?

(b) In two separate diagrams superimpose sets of indifference curves on Hillarys budget set consistent with two possible work-welfare combinations: (i) Hillary is on welfare and does not work, and (ii) Hillary is not on welfare. Is there ever a situation in which Hillary will work and simultaneously receive welfare? Please explain.

(c) Given your answer to part (b), please explain how labor supply is likely to be affected by this public assistance program.

(d) There is an alternative proposal to make public assistance benefits only $200 per week, and then to reduce these benefits by only 50 cents per dollar earned. Please illustrate the effect of this proposal using the consumption/leisure diagram. What effect would this
reform have on Hillary's labor supply? Answer this for both work-welfare combinations you considered in part (b). Is she better off under this proposal than under the current welfare system?