Folkland is considering two alternative tax systems, an income base tax system and a consumption based

tax system. Folkland is a little country that lives only two periods and where all its citizens are identical:

They can work the first period of their lives at a wage of 1 and can either consume or save the proceeds of

their work. If they save they get a rate of return of 5%.The preferences of their citizens are given by utility

function

log(a) + log((1) + log(c2)

where l, is the amount of leisure that they can enjoy in the first period of their lives. Their total endowment

of time is 1. They cannot work in the second period. The government has to finance total expenditures of

.15. in the first period and nothing in the second period. The government can borrow and lend at the same

rate of return as the households.

(a) (10 points) What labor income tax rate does the government have to use if it is its only tax.

(b) (10 points) Imagine now that households also have an endowment of 3 units of consumption in the first

period that they do not need to work for. What second period consumption tax rate will the government

use if it is its only tax instrument?

(c) (10 points) The government is considering an income tax rate in only one period as its instrument. What second period tax rate would it need to use?