Which of the following statements about the income and substitution effects of an income tax rate increase is true?
A) The income and substitution effects are contradictory behavioral reactions.
B) From the government's perspective, the substitution effect is more desirable than the income effect.
C) Faith in the income effect is the foundation for supply-side economic theory.
D) Dynamic forecasts of incremental tax revenues must consider the potential income effect but not the potential substitution effect of a rate increase.

Question

Quizplus · Accepted Answer

The income and substitution effects are contradictory because the income effect suggests people will work more to maintain their income after a tax increase, while the substitution effect suggests they will work less because leisure becomes relatively cheaper compared to work.

Which of the Following Statements About the Income and Substitution