Since the 1980s, individuals’ UI benefits have been subject to the federal personal income tax (but not Social Security taxes). However, in 2009, the taxation of UI benefits for certain individuals was temporarily suspended. Suppose Wang’s earnings are taxed at a rate of 15 percent by the personal income tax and at a combined rate of 7.45 percent by the Social Security and Medicare payroll taxes. Suppose that if Wang becomes unemployed, unemployment insurance replaces 50 percent of his before tax earnings and benefits are available for two weeks.

a. Prior to the 2009 legislation, what percent of Wang’s after tax income was replaced by UI? What happened to the replacement rate as a consequence of the 2009 legislation? What are the implications for the effects of UI on unemployment?

b. Diagram Wang’s budget constraint showing the tradeoff between weekly income and hours of leisure per week, both when he is collecting UI and when he is off of UI. What are the consequences for hours worked if UI benefits are extended past their two week limit?