The country of Adventureland has two citizens, Bill and Ted.
Bill has a private legal business. He earns $50 per hour. At a tax rate of 0%, Bill works 20 hours.
At a 25% tax rate, he works only 16 hours, and at a 40% tax rate, he works only 8 hours per week.
Ted works in a manufacturing job. He works 20 hours per week and earns $6 per hour, regardless of the tax rate.
The government is considering imposing an income tax of either 25% or 40% on Bill and using the revenues to make transfer payments to Ted.
The accompanying table summarizes the three possible policies. Does either tax policy raise social welfare? Are either of the policies obviously less than optimal? Explain your answers.
Effects of Redistributive Policies in Adventureland
|
|
0%
|
25%
|
40%
|
|
Bill's pretax income
|
$1000
|
$800
|
$400
|
|
Stirs taxes
|
0
|
200
|
160
|
|
Bill's net income
|
1000
|
600
|
240
|
|
Ted's pretax income
|
120
|
120
|
120
|
|
Ted's transfer payment
|
0
|
200
|
160
|
|
Ted's net Income
|
120
|
320
|
280
|