In the united states, people must pay taxes to the government out of their current incomes. For example, suppose a family is making $100,000 per year and is facing a tax rate of 20 percent. Then, that family must pay $20,000 to the government at the end of the year. However, income tax laws allow taxpayers to reduce their tax liabilities for a number of reasons. The reductions in taxes take two different forms called deductions and credits. A deduction is an amount deducted from the income. For example, you can deduct the interests you pay on your mortgage or students loans from your incomes in calculating your taxes. Suppose the annual interest on your student loan is $10,000. Then you will deduct this $10,000 from your income and pay tax on the remaining $90,000. In this example, your tax liability will reduce to $18,000 (20% of $90,000). A credit is an amount subtracted from the tax liability. For example, if you have children or dependents to take care of, you can take some credit for the related expenses. Suppose your child and dependent credits amount to $3,000. Then, you will subtract this amount from your tax liability of $18,000 and pay only $15,000 to the government. An important tax credit to help out low-income working families is earned income tax credit(EITC). If members of a family have jobs but their nominal wages are too low so that the family is considered poor, the government allows that family to subtract some money from its tax liability. In the event that that family is so poor that it does not have any tax liability (which is normally the case), the government actually pays some money to that family. So, in effect, the EITC increases the wages earned by low-income families. Research seems to indicate that when a two-earner family receives an EITC, one of the members (mostly wives with children) reduce their work hours or quit their jobs. An economist would say that for such families: Group of answer choices The income effect of a change in nominal wage dominates the substitution effect. The substitution effect of a change in nominal wage dominates the income effect. The income effect of a change in nominal wage equals the substitution effect.
In the united states, people must pay taxes to the government out of their current incomes. For example, suppose a family is making $100,000 per year and is facing a tax rate of 20 percent. Then, that family must pay $20,000 to the government at the end of the year. However, income tax laws allow taxpayers to reduce their tax liabilities for a number of reasons. The reductions in taxes take two different forms called deductions and credits.
A deduction is an amount deducted from the income. For example, you can deduct the interests you pay on your mortgage or students loans from your incomes in calculating your taxes. Suppose the annual interest on your student loan is $10,000. Then you will deduct this $10,000 from your income and pay tax on the remaining $90,000. In this example, your tax liability will reduce to $18,000 (20% of $90,000).
A credit is an amount subtracted from the tax liability. For example, if you have children or dependents to take care of, you can take some credit for the related expenses. Suppose your child and dependent credits amount to $3,000. Then, you will subtract this amount from your tax liability of $18,000 and pay only $15,000 to the government.
An important tax credit to help out low-income working families is earned income tax credit(EITC). If members of a family have jobs but their nominal wages are too low so that the family is considered poor, the government allows that family to subtract some money from its tax liability. In the event that that family is so poor that it does not have any tax liability (which is normally the case), the government actually pays some money to that family. So, in effect, the EITC increases the wages earned by low-income families.
Research seems to indicate that when a two-earner family receives an EITC, one of the members (mostly wives with children) reduce their work hours or quit their jobs. An economist would say that for such families:
When individuals experience an increase in their effective income through tax credits, it can modify their work-related decisions, potentially impacting labor supply.
This concept functions within the model of two economic phenomena: the income effect and the substitution effect, each pulling labor supply decisions in opposite directions when a change in nominal wages occurs.
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