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Consider a simplified example economy where 1,000 identical house- holds each earn $100,000 per year, exclusively through labour income. The government taxes labour income at
Consider a simplified example economy where 1,000 identical house- holds each earn $100,000 per year, exclusively through labour income. The government taxes labour income at a (flat) rate of 15%, and there- fore generates $15,000,000. Based on this data, the government plans to increase the labour income tax rate to 25%. Its economists fore- cast that the government's revenue following this tax increase will be $25,000,000. Use the Lucas critique to criticize this forecast. That is, explain what could go wrong, why it could go wrong, and how this potential failure mode relates to the Lucas critique. [
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