President Bush’s income tax cuts enacted in 2001 have come under increasing scrutiny due to the federal government’s subsequent budget situation with an anticipated deficit for the next several years. Critics are suggesting that the income tax rate reductions should be repealed, at least partially. Use a labor/leisure choice model in graphical form to analyze the likely impact of raising an income tax rate on labor supply.
a. Illustrate and explain the effect of raising the income tax rate on a worker’s budget line.
b. Illustrate and explain the effect of raising the income tax rate on a worker’s labor supply.
c. Explain the conditions under which a worker would react to the tax rate increase by working less.