Consider a two period model in which consumers receive exogenous income y in the first period and y 0 in the second period. Suppose that the government taxes the individuals with a lump-sum tax t in the first period and t 0 in the second period. Suppose that legislatures propose three policies to increase the welfare of households. The first policy is to reduce current period taxes without changing government spending. The second policy is to decrease first-period government spending and decreasing the current period taxes by the same amount. Finally, the third policy is to decrease the first-period government spending as in the second case but instead of decreasing the taxes, use the reduction in government spending to decrease the government debt.

(a) (35 points) Analyze the impact of each policy proposal on the first and second-period consumption, and saving of the consumer. Compare the welfare implications of each policy. Which policy do you think the government should implement?