Question: u(c, l) = c + 4 l. The earned income tax credit (EITC) is a negative labor income tax that replaced the old means

u(c, l) = √ c + 4√ l.

The earned income tax credit (EITC) is a negative labor income tax that replaced the old means tested welfare program to fight poverty in the US. In this program the government pays low wage workers additional income that is proportional to their earned income at work. Let s denote the proportion. After this wage subsidy workers’ take home wage income becomes (1 + s)w(1 − l). Suppose that Rose qualifies for a 20% subsidy. Rose’s new budget constraint after the welfare reform is c ≤ (1 + 20%)· 15(1 −l) + 2 and the marginal benefit of working a bit more becomes (1 + 20%) · 15. With EITC what are Rose’s optimal allocation of time and consumption?

How much does it cost the government to implement EITC for Rose? Is it more expensive to a means tested program?

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Answer Roses optimal allocation is to consume 144 units of goods with 16 hours to work and 06 hour of leisure time EITC creates a budget constraint c 1 20 151 l 2 32 151 l To maximize her welfare Rose ... View full answer

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