7. Self-employed workers in the United States must pay Social Security taxes equal to 12.4% of any income up to $128,700 in 2018. This income level of

$128,700 is known as the “cap.” Income in excess of the cap is not subject to Social Security tax, so self-employed workers with incomes exceeding

$128,700 pay $128,700 * 0.124 = $15,958.80. Now consider two proposals designed to increase Social Security tax revenue. Proposal A increases the cap to $155,685.50 so that Social Security taxes equal 12.4% of income up to $155,685.50. Proposal B increases the Social Security tax rate to 15%, but leaves the cap unchanged at $128,700. For people with income that always exceeds the cap, the amount of Social Security tax is the same under Proposal A

($155,685.50 * 0.124 = $19,305) as under Proposal B

($128,700 * 0.15 = $19,305). There are no planned changes in future Social Security benefits anticipated by current workers.

a. Sally is self-employed and earns $175,000 per year.

What are the effects of Proposal A and Proposal B on Sally’s labor supply? Under which proposal would she supply a greater amount of labor?

Explain your answers using the concepts of income effect and substitution effect.

b. Fred is self-employed and earns $50,000 per year.

What are the effects of Proposal A and Proposal B on Fred’s labor supply? Under which proposal would he supply a greater amount of labor?

Explain your answers using the concepts of income effect and substitution effect.