Menu

[10 Points] Taxes Are Often

0 Comment

4. [10 Points] Taxes are often distortionary, and firms everywhere complain about how dividend
taxes (profit taxes) affect their hiring decisions. Consider a firm that operates a constant returns
to scale technology that uses capital and labor to produce. The firm owns K units of capital. The production function is:
F (K, N) = zKaNl‘ The profits of the firm are taxed at a rate 7′. That is, for every dollar of profits that the firm
makes it must pay 7′ to the government. The owners of the firms claim that this reduces their incentives to create jobs. (a) Pose the firm’s problem (the firm cares about after tax profits).
(b) Find the firm’s FOC for labor. Interpret it. (c) After a lot of lobbying the government agrees to reduce dividend taxes (reduce ’7′). Will this
induce the firm to hire more labor? Explain why or why not. Economics