Question

Assume the gross wage of w=$10 per hour and gross non-wage income YN = $5000 per year. Assume a maximum of 6,000 hours of leisure per year (T= 6000 per year ), so that full income for the worker is $65,000.

Draw the budget constraint under each of the following taxes and transfer schemes.

1. A progressive tax on earnings where the tax rate is 20% on earnings up to $50,000 and 30% on earnings above $50,000.

Answer 1

We can calculate the consumption (which is equal to disposable income) at various level of leisure hours/ hour worked after incorporating progressive tax rates given.

No. of hours worked, H	Leisure hours, T	Non wage income, YN	Wage income, YW	Total income	Tax rate	Tax	Disposable income
0	6000	5000	0	5000	20%	1000	4000
500	5500	5000	5000	10000	20%	2000	8000
1000	5000	5000	10000	15000	20%	3000	12000
1500	4500	5000	15000	20000	20%	4000	16000
2000	4000	5000	20000	25000	20%	5000	20000
2500	3500	5000	25000	30000	20%	6000	24000
3000	3000	5000	30000	35000	20%	7000	28000
3500	2500	5000	35000	40000	20%	8000	32000
4000	2000	5000	40000	45000	20%	9000	36000
4500	1500	5000	45000	50000	20%	10000	40000
5000	1000	5000	50000	55000	30%	11500	43500
5500	500	5000	55000	60000	30%	13000	47000
6000	0	5000	60000	65000	30%	14500	50500

Budget constraint can be drawn as under