Problem
Suppose that a consumer has income y in the current period and income y' in the future and faces proportional taxes on income in both periods. That is, the consumer pays a tax ty in the current period and t'y'in the future period. The government wishes to collect tax revenue to finance its spending g in the current period and g in the future period. The real interest rate is r.
a. Derive the consumer's inter-temporal budget constraint.
b. Derive the government's inter-temporal budget constraint.
c. Suppose that the government's total spending does not change, but the government changes the way it finances this spending by reducing t and increasing t. What effect, if any, does the change in the tax rates have on the consumer's choice of current and future consumption, and on savings? Does Ricardian equivalence hold? Explain why or why not.
The response should include a reference list. Double-space, using Times New Roman 12 pnt font, one-inch margins, and APA style of writing and citations.