In the labor market, the income tax creates a tax wedge which raises the ________ wage rate, reduces the ________ wage rate, and ________ employment.

Question

Quizplus · Accepted Answer

The income tax creates a tax wedge between the before-tax wage rate paid by employers and the after-tax wage rate received by employees. The tax wedge increases the cost to the employer of paying an employee, which in turn reduces the quantity of labor demanded at the given wage rate. This decrease in labor demand leads to a reduction in the after-tax wage rate, meaning employees receive less take-home pay for their work. The overall effect of the income tax on the labor market is to decrease employment.

In the Labor Market, the Income Tax Creates a Tax