Question

Suppose preferences for consumption and leisure are: u(c, l) = ln(c) + θ ln(l)

and households solve:

max_c,l u(c, l)

s.t. c=w(1−τ)(1−l)+T

Now suppose that in both Europe and the US we have:

θ = 1.54

w=1

but in the US we have:

τ = 0.34

T = 0.102

while in Europe we have:

τ = 0.53

T = 0.124

The values for τ and T above are not arbitrary. If you did the calculations correctly, you should find that both governments have balanced budgets (up to rounding error), i.e. the government collects τwh∗ and redistributes all the tax revenue back as transfers T. Check that this is the case. In other words, that tax revenue equals transfers in each country.

Answer 1