Assume an income tax was doubled. Describe what would happen to labor

Assume an income tax was doubled. Describe what would happen to labor supply and leisure. Can we be about the net effect on labor supply?

What will be an ideal response?

ANSWER

The doubling of the income tax is going to cause individuals to substitute away from the taxed activity, i.e., earning income. Thus the substitution effect of the tax is going to be decreasing labor supply and increasing leisure. The decline in after-tax income, however, is likely to cause the person to work more to make up some of the after-tax income lost from the new tax. Depending upon how large the income effect is the number of hours worked after the tax could actually increase. Since the income effect could dominate the substitution effect, we cannot be sure that the doubling of the income tax would reduce labor supply.