5. Problems and Applications Q5 A senator wants to raise tax revenue and make workers better off. A staff member proposes raising the payroll tax paid by firms and using part of the extra revenue to reduce the payroll tax paid by workers. True or False: This arrangement would most likely make workers worse off because the tax wedge would be larger. True False

True

Explanation:

This will not accomplish the senator's goal because payroll taxes work in the same way as taxes on goods. Labor is the good here and wage is the price that is being paid for it. Tax is a wedge between what firms pay and what workers receive. When a payroll tax is enacted the wage received by workers falls and that paid by firms rises. The payment of taxes will be made by the firm according to the legislation and the wages for the workers will decrease according to the elasticity of demand and supply of labor market and ultimately the tax paid by the firms and the workers will not change.

True

Explanation: The tax wedge here is the difference between the wages employees take home and how much employers actually pay to employ them. It is also the difference in the market forces of demand and supply due to imposing tax on goods and services.

Firstly, the burden of tax will not rest with firms but will be transferred to consumers through goods and services which will affect demand. Also increasing the payroll tax paid by employers will make employees worse off as the burden of payroll tax still rest on the employees, it will only decrease  take home wages.