In a hypothetical economy, there is a simple proportional tax on wages imposed at a rate t.

Question:

In a hypothetical economy, there is a simple proportional tax on wages imposed at a rate t. There are plenty of jobs around, so if people enter the labor force, they can find work. We define total government receipts from the tax as

T = t Ã— W Ã— L

Where t = the tax rate, W = the gross wage rate, and L = the total supply of labor. The net wage rate is

W_n = (1 - t) W

The elasticity of labor supply is defined as

Percentage of change in L

Suppose t was cut from 0.25 to 0.20. For such a cut to increase total government receipts from the tax, how elastic must the supply of labor be? (Assume a constant gross wage.) What does your answer imply about the supply-side assertion that a cut in taxes can increase tax revenues?

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