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ECO3020F tutorial 8
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1 Atctax cut in period
AGCINI
2
in period
future tax liability
wealth A
ÉE
E Ez MC
off
f
tax cnn.owri.am
É credit constrained
B f
59 Qingvsiending
entire tax cutspent
on c
current consumption
notconstrained not saving
IEfaama
Assuming the consumer receives a cut in taxes in current period:
benefits constrained
• Period 1 taxes change by Dtwith a corresponding change of Dt Itv1 in future taxes
• The e ect of change in current b future taxes is to shift endowment from E1 point to Ez
• Consumer now chooses E2 as optimal consumption bumble on IC I2
Assuming the government pays r1 on debt
• The consumer’s future tax liability, shown by the tax cut, is
Atc tri
As they choose a point of endowment before and after the tax cut, period 1 consumption increases
by the amount of the tax cut ( At) . Current consumption increases as the government is setting a
low interest loan through the tax cut. If borrowing was possible at r1, G would be the chosen point.
When the consumer receives a tax cut , they experience a current tax cut and a future increase in
taxes. This shifts budget constraint from AE1B to AE2F. The consumers optimal bundle shifts from
E1 to E2 and the entire tax cut is had by the consumer. Current consumption increases, while future
consumption decreases and as they are credit constrained they save zero (the entire tax cut is spent
on Current consumption.)
Decrease in creditworthy borrowers
LEDC borrowing
defaultpremium
r
higher
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