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Consider two alternative specifications, a) and b), of the one-period model of consumption and leisure: Preferences: U (C, l) a) Budget constraint with lump sum
Consider two alternative specifications, a) and b), of the one-period model of consumption and leisure: Preferences: U (C, l) a) Budget constraint with lump sum taxes: T + w(h l) = C, where T represent lump-sum taxes, i.e. taxes that are independent of your actions. b) Budget constraint with proportional taxes on labor income: + (1 )w(h l) = C where is the tax rate, such that for every dollar earned in wages the household only receives (1 ) dollars. Show that the consumer is better off with a lump-sum tax rather than a proportional tax on labor income given that either tax yields the same revenue for the government. Use the diagram with the budget line and the indifference curve to answer this question. Explain your answer. (Hint: Begin by depicting the proportional tax and then explore what happens when it is replaced by a lump sum tax
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