In 2009, the then Labour Government announced that the annual income above 150k would be taxed at a 50% rate rather than the 40% rate it had been previously. Tax rates on income below 150k remain unchanged. This means that if you earn 200k the tax bill on your income above 150k would rise from 20k (40% of 50k) to 25k (50% of 50k). This change affected about 1% of income earners. In 2012 the new Coalition government partially reversed this policy cutting the tax rate back to 45%.

It argued that the increased tax rate had raised "next to nothing" in the way of extra revenue ( http://www.bbc.co.uk/news/uk-politics-17450719 ).

Suppose that:

- You have no non-labour income

- Your income below 150k is not taxed at all (it is in reality but I don't want to make

things too complicated)

- You earn 150k if you work 2000 hours a year

Show how an increase in the tax rate on your income above 150k alters your budget constraint

1. If you were originally working below 2000 hours a year how will the increase in the tax rate affect your decision about how much to work. (6 marks)
2. If you were originally working above 2000 hours a year how will the increase in the tax rate affect your decision about how much to work. Phrase your answer in terms of the income and substitution effect. (6 marks)
3. On a diagram representing the tax revenue re tax revenue goes down when the tax rate goes up? (5 marks)
4. This model assumes that it is only labour supply that responds to the change in the tax rate. Are there other ways in which behaviour might change because of the higher tax rate? (3 marks)