John has a utility function of the following: U(L, C) = LB C1-B, where L is leisure and C is consumption. If he works, he receives a real wage w. Outside of the labor market, he has non- labor market income V. And his endowment of time T is normalized to 1. And the price of goods p is also normalized to 1.
(a) Now, consider the case where John is subject to a 10% income tax on labor income only. What is his new optimal supply of labor?
(b) Assuming =1/2, V = 100, w = 200, what is his optimal supply of labor?
(c) Compare the result in (a) and (b). Elaborate on how income tax affects John’s labor supply decision.