Application: Taxation and Supply-Side Economics

A Marginal Tax Rate A marginal tax rate is a proportional tax on income A rise in the tax rate lowers employment and investment

Taxation and Labor A higher personal income tax of t reduces employment in the economy It makes labor more expensive for firms w N Labor supply MPN w’ w w’(1-t) NN’

Corporate Income Tax A higher corporate income tax reduces the domestic allocation of capital Since the world return to capital is r, corporations required the gross return to capital to be r’ r I supply MPK-d [MPK-d](1-t) r’(1-t) =r r’ II’

Tax on Savings A rise in dividend income tax reduces domestic savings r S,I r r’=r(1-t) S’ Savings S

The Laffer’s Curve A tax raise from t 0 to t 1 increases Tax Revenues A tax cut from t 2 to t 1 also increases tax revenues Tax Revenue Tax rate t 0 t 1 t 2 0 1

Reagan A marginal tax rate is a tax to the marginal supply of labor or capital A tax on labor makes labor more expensive and raises the marginal cost of hiring workers Since the marginal cost has gone up, but the marginal product has not changed, firms hire fewer workers

Reagan