Self-employed workers in the United States must pay Social Security taxes equal to 12.4% of any income up to \($118,500\) in 2015. This income level of \($118,500\) is known as the “cap.” Income in excess of the cap is not subject to Social Security tax, so selfemployed workers with incomes exceeding \($118,500\) pay \($118,500\) * 0.124 = \($14,694.\) Now consider two proposals designed to increase Social Security tax revenue. Proposal A increases the cap to \($143,347\) so that Social Security taxes equal 12.4% of income up to \($143,347.\) Proposal B increases the Social Security tax rate to 15%, but leaves the cap unchanged at \($118,500.\) For people with income that always exceeds the cap, the amount of Social Security tax is the same under Proposal A (\($143,347\) * 0.124 = \($17,775)\) as under Proposal B (\($118,500\) * 0.15 = \($17,775).\) There are no planned changes in future Social Security benefits anticipated by current workers.

a. Sally is self-employed and earns \($150,000\) 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.