Mark lives for two periods, earning $50; 000 in income in period 1, which he divides between

current period consumption and saving for period 2. The interest rate on his saving is 10%

per period.

(a) The government is considering three tax proposals. Write down Mark’s intertemporal

budget constraint in each of the following case, draw the corresponding budge line, and

label the intercepts and slope.

(i) a 10% tax on labor income.

(ii) a 10% tax on consumption in both periods.

(iii) a 50% tax on interest income from saving.

(Note that only one proposal will be chosen. Do not combine any taxes.)

(b) How would Mark rank the above three taxes? Explain.

(c) Suppose that Mark saves $15,000 if there is no tax on saving. The third proposal (iii)

is actually imposed. The income and substitution eect exactly cancel out so that this

tax has no eect on his savings. Draw a set of indierence curves consistent with this

response. What is Mark’s after-tax consumption in period 2?

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