Question

Is an increase in the marginal income tax rate reflected by a shift in the after-tax supply of labor or a movement along the supply curve when the pretax wage rate is on the vertical axis? Explain your answer. 1. A shift in the supply curve. An increase in the marginal tax rate reduces wages, so workers will need to increase the number of hours they work at every wage rate. 2. A shift in the supply curve. An increase in the marginal income tax rate reduces the after-tax wage rate, causing the number of hours a worker is willing to work at every pretax wage to fall. 3. A movement along the supply curve. An increase in the marginal tax rate increases wages, causing a rise in the number of hours worked. 4. A movement along the supply curve. An increase in the marginal tax rate reduces wages, causing a rise in the quantity of hours worked.

Answer 1

W is the pretax wage rate, which is vertical; S is the supply of labor.

Any change in W would affect on S as “movement along the supply curve”; but, it is not happening here, since “tax” is not a part of pretax wage rate (W); therefore, there would be a shift in S curve as S1; it would shift to the right, because at the same pretax wage rate, workers would work increasing hours since after the deduction of tax they would be able to get equivalent income as before.

In the picture, the supply increases from L to L1.