5. LO 4 Suppose, as in the federal income tax codefor the United States, that the representative con-sumer faces a wage income tax with a standarddeduction. That is, the representative consumerpays no tax on wage income for the first x units ofreal wage income, and then pays a proportionaltaxt on each unit of real wage income greater thanx Therefore, the consumer's budget constraintgiven by C wh -D + if wh- D=x., orC (1-wh-D+ tx+ if_wCh = D2Now, suppose that the government reducestax deduction x Using diagrams, determine theeffects of this tax change on the consumer, andexplain your results in terms of income and substitution effects. Make sure that you consider twocases. In the first case, the consumer does not payany tax before x is reduced, and in the secondcase, the consumer pays a positive tax before xis reduced

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Asked Oct 19, 2019
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5. LO 4 Suppose, as in the federal income tax code
for the United States, that the representative con-
sumer faces a wage income tax with a standard
deduction. That is, the representative consumer
pays no tax on wage income for the first x units of
real wage income, and then pays a proportional
taxt on each unit of real wage income greater than
x Therefore, the consumer's budget constraint
given by C wh -D + if wh- D=x., or
C (1-wh-D+ tx+ if_wCh = D2
Now, suppose that the government reduces
tax deduction x Using diagrams, determine the
effects of this tax change on the consumer, and
explain your results in terms of income and sub
stitution effects. Make sure that you consider two
cases. In the first case, the consumer does not pay
any tax before x is reduced, and in the second
case, the consumer pays a positive tax before x
is reduced
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5. LO 4 Suppose, as in the federal income tax code for the United States, that the representative con- sumer faces a wage income tax with a standard deduction. That is, the representative consumer pays no tax on wage income for the first x units of real wage income, and then pays a proportional taxt on each unit of real wage income greater than x Therefore, the consumer's budget constraint given by C wh -D + if wh- D=x., or C (1-wh-D+ tx+ if_wCh = D2 Now, suppose that the government reduces tax deduction x Using diagrams, determine the effects of this tax change on the consumer, and explain your results in terms of income and sub stitution effects. Make sure that you consider two cases. In the first case, the consumer does not pay any tax before x is reduced, and in the second case, the consumer pays a positive tax before x is reduced

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Expert Answer

Step 1

Case 1

In the first case when consumers do not pay taxes earlier, a reduction in tax deduction can have two effects. That is if real wage income earned by a labor is still less than the amount of x than there will be no change on the consumer. In the second situation when tax deduction reduces to a point where wage income earned by the consumer is greater than the tax deduction than he is required to pay more and hence leads to the changes shown in the diagram below. In the ...

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