1. Homework #10 Government Finance

2. 1. Draw an inter-temporal budget constraint for a decision maker who has the following incomes, tax rates, and interest rates: Present Income: $50,000 Future Income: $50,000 Interest Rate: 5% Income Tax Rate: 20% 2. True, False, or Uncertain? Decreasing the personal income tax rate will cause savings to decline. 3. True, False, or Uncertain? Decreasing the personal income tax rate will cause borrowing to increase if interest payments are deductible

3. Y P = $50,000 Y F = $50,000 Present Future Y P+B-I+T = $98,000 Y F+S+I-T = $102,000 Present ($50,000) + Borrowing ($50,000) – Interest ($2,500) + Tax Deduction ($500) = $98,000 Future ($50,000) + Saving ($50,000) + Interest ($2,500) – Taxes ($500) = $102,000 Present Income: $50,000 Future Income: $50,000 Interest Rate: 5% Income Tax Rate: 20% 1.

4. Uncertain. If the income effect is dominant, a tax decrease may decrease savings as is represented by point II. If the substitution effect is dominant, a tax decrease may increase savings as is represented by point III. True, False, or Uncertain? Decreasing the personal income tax rate will cause savings to decline. 2.

5. False. Both the income and substitution effects suggest that a decrease in the income tax will cause borrowing to decrease. The income effect says that you’ll move somewhere around point II, and the substitution effects says you’ll move somewhere around point III. However, both say that you’ll decrease borrowing. True, False, or Uncertain? Decreasing the personal income tax rate will cause borrowing to increase if interest payments are deductible. 3.

6. Future Present Saving Borrowing Saving AmountBorrowing Amount Increase Decrease Increase Tax Present Future Substitution Income Saving Present Future Substitution Income Borrowing #2 - Uncertain #3 - False