Question

1. (50 points) What follows is a slightly simplified version of the earned income tax credit (EITC) which has become the largest income transfer program in the U.S. You will be asked to draw budget constraints for an individual (with two children) with and without EITC Consider an individual whose only sources of income are labor and EITC. The market wage rate for a person with this individual's skills is S8.00 per hour. The individual is not subject to any income or social security tax. The individual has 5,000 hours a year that could conceivably be spent on wage earning activities (approximately the hours of an investment banker). Ifthis person's annual wage income is less than $9,700, he (she) receives a subsidy of 40% ofwage income in the form ofa tax credit from the federal government. Ifincome is between S9,700 and S12,700, the subsidy is S3880. For every dollar ofwage income earned in excess of S12,700, the tax credit is reduced by 20 cents Carefully draw a diagram that depicts this individual's budget constraint between leisure and after-tax annual income with and without the EITC. If there are several segments in the EITC budget line identify them as segment 1, segment 2, etc. It is better to use graph paper to do this, also draw a large graph. a. b. What is opportunity cost of leisure in the absence of EITC program? Explain what happen to the opportunity costs of leisure as you move along the different segments of the EITC budget line and compare the opportunity cost of leisure without the program to the opportunity costs of leisure with the program. c. How would the income and substitution effects be different on each segment of the EITC?

Answer 1

Answer:

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