(0) In regime 0, K(0) < B and l are eligible for benefit B, and they don’t work.
(1) In regime 1, K(1)
B and l don’t get benefit B, and they work and earn L.
On benefit, the welfare rule is strict on not-working, while by assumption the black economy can be neglected. Off benefit, the l have no other means of support and thus work, and earn gross L. Since net income cannot be larger, L
K(1)
B.
In the following equations, personal income y takes values H and L. Relation (1-t) below gives the implied tax system, where the personal tax T(y, t) depends upon personal income y and the tax regime t: