A cut in higher rate taxes has two effects. Which statement is correct?

Question

Quizplus · Accepted Answer

A cut in higher rate taxes increases the net wage rate, which increases the opportunity cost of leisure. This is the income effect. The substitution effect states that as the wage rate increases, individuals will substitute work for leisure, decreasing the amount of time spent on leisure activities. Therefore, the substitution and income effect work in opposite directions. Option B is the correct answer as it correctly identifies that the substitution effect increases the opportunity cost of leisure.

A Cut in Higher Rate Taxes Has Two Effects