Question

Show that the consumer is better off with a lump-sum tax rather than a proportional tax...

  1. Show that the consumer is better off with a lump-sum tax rather than a proportional tax on wage income (as in question 3) given that either tax yields the same revenue for the government. You must use a diagram to show this. (Hint: The consumption bundle the consumer chooses under the proportional tax must be just affordable given the lump-sum tax.)
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Answer #1

From the diagram we can see that, initially without any tax the original choice of a consumer is at point A on IC1, the highest IC.

But after the proportional tax, budget line pivot and new bundle is at point B on IC2, on the lower IC than before. consumption bundle decrease.

But due to imposition of income tax, money income decrease, but consume shift on the higher IC at IC3.

He is better off in income tax than in proportional tax, bcoz in proportional tax, his original bundle deteriorates, but in income tax his consumption doesn't deteriorates and he can achieve maximum satisfaction on higher IC.

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