In the U.S., the social security system is funded by a payroll (wage) tax of 12.4% that is split equally between employer and employee; i.e. the statutory incidence of the social security tax falls half on employers and half on employees. In this exercise we consider how this split in statutory incidents impacts the labour market. Assume throughout that labour supply is upward sloping.

(a) Illustrate the labour supply and demand graph and indicate the market wage w and employment level l in the absence of any taxes.

(b) Which curve shifts as a result of the statutory mandate that employers have to pay the government 6.2% of their wage bill? Which curve shifts because of the statutory mandate that employees pay 6.2% of their wages in social security tax?

(c) Suppose the wage elasticity of labour demand and supply are equal in absolute value at the pre-tax equilibrium. Can you illustrate how the market wage at the post-tax equilibrium when both parts of the social security tax are taken into accountmight be unchanged from the initial equilibrium wage w?

(d) In your graph, illustrate what the imposition of the 2-part social security tax means for the take home wage ww for workers. What does it mean for the real cost of labor wf that firms incur? Suppose that labour demand and supply in the absence of taxes are given by ld = (Aw)/ and l s = (w B)/.

(e) Determine the equilibrium employment level l and the equilibrium wage w.

(f) Now suppose the government imposes a per-unit tax t on workers and a second per-unit tax t on employers. Derive the new labour demand and supply curves that incorporate these (as you would when you shift demand and supply curves in response to statutory tax laws).

(g) Determine the new equilibrium wage and employment level. Under what condition is the new observed equilibrium wage unchanged as a result of the two-part wage tax? Is there any way that employment will not fall? (h) Determine the take-home wage ww for workers and the real labor cost wf for firms