Taxing Goods versus Lump Sum Taxes: I have finally convinced my local congressman that my wife’s taste for grits are nuts and that the world should be protected from too much grits consumption. As a result, my congressman has agreed to sponsor new legislation to tax grits consumption which will raise the price of grits from $2 per box to $4 per box. We carefully observe my wife’s shopping behavior and notice with pleasure that she now purchases 10 boxes of grits per month rather than her previous 15 boxes.
A: Putting “boxes of grits per month” on the horizontal and “dollars of other consumption” on the vertical, illustrate my wife’s budget line before and after the tax is imposed. (You can simply denote income by I.)
(a) How much tax revenue is the government collecting per month from my wife? Illustrate this as a vertical distance on your graph.
(b) Given that I live in the South, the grits tax turned out to be unpopular in my congressional district and has led to the defeat of my congressman. His replacement won on a pro-grits platform and has vowed to repeal the grits tax. However, new budget rules require him to include a new way to raise the same tax revenue that was yielded by the grits tax. He proposes to simply ask each grits consumer to pay exactly the amount he or she paid in grits taxes as a monthly lump sum payment. Ignoring for the moment the difficulty of gathering the necessary information for implementing this proposal, how would this change my wife’s budget constraint?
B: State the equations for the budget constraints you derived in A(a) and A(b), letting grits be denoted by x1 and other consumption by x2.