Question

1. The nation of Freedonia is considering the adoption of three healthcare policies, each of which would be funded by a new flat tax of t% on labor income. In each case, explain and illustrate the combined effects the new policy (including the tax) would have on labor market participation, hours worked and utility for people at various levels of current income and hours worked. For simplicity, you may assume that all consumption consists of healthcare.
   1. The new healthcare program is means tested, like Medicaid, and has a benefit reduction rate of less than 100%.
   2. Freedonia funds a fixed amount of healthcare that everyone receives.
   3. Freedonia provides a fixed subsidy for healthcare that people receive only if they work at least eight hours per day.
      1. Assume the subsidy is not larger than the amount of tax paid at eight hours of work.
      2. How does your answer change if the subsidy is larger than the tax paid at eight hours of work?

Answer 1

Solution

Given that each of the three healthcare policies  would be funded by a new flat tax of t% on labor income.

a.The new healthcare program means tested, like Medicaid, and has a benefit reduction rate of less than 100%.

It means benefits reduce a much lower scale when compared to the scale at which income / earnings rises.So,it means comparatively the higher income will have higher utility.This will urge / motivate the people to increase their earnings.This will lead to increase the labor market participation, hours worked and decrease utility for people at various levels of current income.

b. Freedonia funds a fixed amount of healthcare that everyone receive - No effect on all the above mentioned parameters

c. Freedonia provides a fixed subsidy for healthcare that people receive only if they work at least eight hours per day.

(i) Assume the subsidy is not larger than the amount of tax paid at eight hours of work.-

The average working hours per person will move towards 8 hours a day as there is compulsion to work for 8 hours in order to receive the fixed subsidy.

This will also encourage people to not work beyond 8 hours per day as there is no incentive in the form of receiving extra subsidy for extra number of hours worked over and above the normal 8 hours per day.

(ii) How does your answer change if the subsidy is larger than the tax paid at eight hours of work?

The number of hours will increase beyond 8 hours up till the point where the tax paid equals the subsidy being paid by the government.

Hope this solution helps!! Please give a thumbs up rating for this solution!! Feel free to comment in case of any further clarification in the solution !!