Question

Can you describe the effects on income inequality of the following changes to the federal taxation system:

1. Raise the federal marginal tax rate in the two highest income tax brackets by 2 percentage points.  

2.Increase the federal payroll tax paid by employers by 1 percentage point for any worker the employer pays more than $200,000 in a calendar year.

Please explain the pros and cons of such a change and any and all effects it will have on labor supply, demand for labor, and employees tradeoff between working hours and leisure. Would this work to combat income inequality? Please be as detailed as possible.

Answer 1

1)

Since here tax rate has been raised for higher income bracket earners, it suggests that tax system is progressive. or higher income people are being taxed at higher rate. Thus, it will lead to equality in society. Revenue collected by the government would be spend on general welfare activities.

it will affect the labor supply adversely. higher income people will be less inclined to supply labor. While demand for labor might rise due to increase in demand after rise in government spending.

Even labor would like to substitute the leisure for working hours. Now it is no longer profitable to supply more labor.

2)

If payroll tax is paid by the employers, the supply of labor will rise. But the demand for labor might not rise since now cost of hiring people would rise. it will not reduce inequality. Fall in demand for labor even might further increase inequalities.

labor will seek to supply more labor and would prefer leisure less. Opportunity cost of leisure will rise.