Rich lives two periods. His earnings in the present are $100; in the future they are $75.6. The interest rate is 8 percent.

a. Suppose Rich’s earnings are subject to a 25 percent tax. Suppose also that interest earnings are taxed at the same rate and interest paid is tax deductible. Using our life-cycle model, show that this tax generates an excess burden.
b. Suppose now that interest payments are not tax deductible. Does this tax generate an excess burden if Rich is a borrower?
c. Now assume the tax is scrapped in favour of a consumption tax. What consumption tax rate would yield the same tax revenue? Does this tax distort the choice between present and future consumption?
d. Now assume the consumption tax in part (c) is instituted, but the deduction of interest payments remains. Does this tax distort the choice between present and future consumption?