Song earns $130,000 taxable income as an interior designer and is taxed at an average rate of 20 percent (i.e., $26,000 of tax). Answer the questions below assuming that Congress increases the income tax rate such that Song's average tax rate increases from 20 percent to 25 percent.

Required:

What will happen to the government's tax revenues if Song chooses to spend more time pursuing her other passions besides work in response to the tax rate change and therefore earns only $97,500 in taxable income?

A. Government's tax revenues would decrease by $1625

B. Government's tax revenues would increase by $1625

C. Government's tax revenues would decrease by $1875

D. Government's tax revenues would increase by $1875

E. Government's tax revenues would remain unchanged

What is the term that describes this type of reaction to a tax rate increase?

A. Income effect

B. Budget constraint

C. Price effect

D. Substitution effect

E. Endowment effect

What types of taxpayers are likely to respond in this manner?

A. Taxpayers with less disposable income

B. Taxpayers with more disposable income