Question

Suppose the labor market in NJ is at its equilibrium status with E* and w*. Suppose the state government of NJ decides to impose a payroll tax, t, on the worker.

a) Show me how the payroll tax affects this labor market by drawing a graph.

b) Indicate producer’s surplus, consumer’s surplus, and deadweight loss on your graph.

Answer 1

Assume market is in equilibrium at point E* where labor hired is L* and wage rate is w*. If government tries to impose a payroll tax of t on the worker, the tax burden will be shared by both the parties.

a) Wage paid by producer rises to W1 while wage received by labor falls to W0 where W1 - W0 is the tax imposed. Labor hired in the market falls to L0 from L*.

b) Consumer surplus falls from A + B + E to A while producer surplus falls from C + D + E to D. Deadweight loss is the area of portion E + F after tax is imposed.