Answer to Question #134312 in Macroeconomics for Amutha

Question

Suppose an individual has preferences over consumption in period 1 and consumption in period 2 (i.e., there is only one consumption good that can be consumed in each period and its price is unity). She has no exogenous wealth, receives an income y only in period 1 but can lend (save) at the interest rate r% per period.
a. Using a revealed preference argument, prove that a per-unit tax t on consumption in each period is weakly preferred to a comprehensive (percentage) income tax t (i.e., on both y and interest income) that raises the same present discounted value (PDV) of revenue.
b. Assuming strictly convex preferences and an interior optimum under both taxes, show that the consumption tax is strictly preferred.

Answer 1

a. Revealed preference is an economic theory regarding an individual's consumption patterns, which asserts that the best way to measure consumer preferences is to observe their purchasing behavior. 

b. A consumption tax is a tax on the purchase of a good or service. Consumption taxes can take the form of sales taxes, tariffs, excise, and other taxes on consumed goods and services.