New Payroll Tax
The question
Assume the economy of Verrand is operating at its natural rate of unemployment with stable, fully anticipated inflation. To fund a new national health program, Verrand's government begins charging employers a tax on every hour of labor they hire, and output per worker-hour is unchanged. Assume the frictional and structural determinants of the natural rate of unemployment are unchanged. Show the short-run effect of this change in the Phillips curve model. Show the effect on the Phillips Curve graph.
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New Payroll Tax: the worked answer
On the Phillips Curve graph, SRPC shifts up (right).
Why SRPC shifts up (right)
The tax is part of what it costs a firm to employ an hour of labor, so with output per worker-hour unchanged it raises per-unit production costs for firms across the economy. Higher unit costs are passed into prices, so the inflation rate associated with any given unemployment rate is now higher and the short-run Phillips curve shifts up and to the right. The prompt holds the frictional and structural determinants of the natural rate constant, so the vertical long-run Phillips curve stays exactly where it is.
What happens to the equilibrium
At the natural rate of unemployment the economy now faces a higher inflation rate, so every short-run unemployment-inflation pairing carries more inflation than before.
The mistake students make on this one
The frequent wrong answer is to move the LRPC right, reasoning that taxing every hour of labor must permanently price some workers out of jobs. The stem holds the frictional and structural determinants of the natural rate constant, and in the AP model a broad rise in per-unit production costs is a short-run supply-side shock, so only the SRPC moves.
On exam day
Any economy-wide rise in per-unit production costs is one shock drawn twice: SRAS left on AD-AS, SRPC up and to the right here. It does not matter whether the cost came from wages, imported inputs, or a tax employers must pay.
How this is graded
The checker reads every curve's position before and after your answer. You are marked correct only when SRPC shifts up (right) and every other curve on the Phillips Curve graph stays where it started — the same standard an AP reader applies to a drawn graph: the right shift, and nothing extra. There is no AI involved; the rubric is the geometry.
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