Payroll Tax- You are an economic consultant to a city that just imposed a payroll tax of $1 per hour of work. This payroll tax is paid by workers through a payroll deduction; for each hour of work, the employer deducts $1 and sends the money to the city government. The initial wage (before the tax) is $10, and total employment is 20,000 hours per day. Use a graph to show the effect of the tax on the equilibrium wage and employment.
To analyze the effect of the payroll tax on the equilibrium wage and employment, we can use a labor market graph. This graph represents the relationship between the wage level on the vertical axis and the employment level on the horizontal axis.
1. Start by drawing a horizontal line to represent the initial wage level before the tax. In this case, the initial wage is $10.
2. Next, draw a vertical line from the intersection of the wage line and the horizontal axis to represent the initial level of employment. In this case, the initial employment is 20,000 hours per day.
3. Now, introduce the payroll tax into the graph by drawing a new wage line. The new wage line should be parallel to the initial wage line but $1 lower at every level of employment. So, if the initial wage was $10, the new wage line will be at $9.
4. Draw a vertical line from the new wage line to the horizontal axis to identify the new level of employment. The intersection of the new wage line and the horizontal axis represents the equilibrium level of employment with the tax.
5. Finally, compare the initial equilibrium employment level (found in step 2) with the new equilibrium employment level (found in step 4). The difference represents the decrease in employment due to the payroll tax.
In summary, the graph will show that the introduction of the $1 payroll tax per hour of work will lead to a decrease in the equilibrium wage (from $10 to $9) and a decrease in the equilibrium employment level.