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Labor Supply Behavior and the Design of Tax and Transfer Policy

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This paper argues that recent empirical evidence on labor supply behavior - showing stronger participation responses than hours-of-work responses - has important implications for the design of tax and transfer policy. Based on a review of recent research in this field, we conclude the following: (i) Conventional ways of evaluating the impact of tax-transfer reforms on economic efficiency have to be revised. (ii) Optimal redistributional policies may well involve negative marginal tax rates at the bottom of the earnings distribution. (iii )T he introduction of the Earned Income Tax Credit (EITC) in the United States in the mid-1970s and the large expansions of the credit during the past two decades did not involve a trade-off between efficiency and equality as suggested by previous estimates. Instead, the EITC has improved both equality and efficiency. (iv) For most European countries, redistribution to the working poor involves a substantially lower trade-off between efficiency and equality than traditional redistributional policies targeted to those out of work.

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This working paper considers how hours of work and labour force participation are likely to respond to tax reforms. As regards hours of work, the analysis looks at married women and lone parents. Married women constitute a group which responds to incentives, as shown by experimental and sample survey studies. Lone parents, an important fraction of the working age population in some countries, often are subject to special tax and income support provisions and have limited sources of alternative income. A second part of the analysis concerns inflows to and outflows from employment, labour force participation and duration of unemployment as they affect men and women in different age groups and with differing family responsibilities. The analysis is based mainly on the well-documented tax reforms in the United Kingdom. The first part of the paper develops the appropriate methodology for analysing labour supply responses to tax changes and the second part attempts to clarify the magnitude ... L’impact des impôts sur l’activité et l’offre de travail Ce document de travail étudie les effets possibles de la reforme de la fiscalité sur le temps du travail et les taux de participation. En ce qui concerne le temps du travail, l’analyse porte sur les femmes mariées et les parents isolés. Les femmes mariées constitue un groupe dont le comportement est influencé par des incitations ainsi que les études d’expériences et d’échantillonnage l’ont démontré. Dans certains pays les parents isolés forme une fraction importante de la population en age actif et bénéficient souvent de dispositions spéciales d’imposition et de soutien des revenus tout en n’ayant que peu de sources alternatives de revenus. Une deuxième partie de l’analyse considère les entrées et sorties de l’emploi, de la population active ainsi que la durée du chômage pour les hommes et femmes dans différents groupes d’age et de situation familiale. L’étude est fondée sur les réformes de la fiscalité au Royame Uni bien documentées. La première partie du document développe le cadre ...
Article
This paper uses the Tax Reform Act of 1986 as a natural experiment to identify the labor supply responsiveness of married women to changes in the tax rate. The Tax Reform Act of 1986 reduced the top marginal tax rate by 44 percent (from 50 percent to 28 percent), but changed less the marginal tax rate for those further down the income distribution. I analyze the response of married women at or above the 99th percentile of the income distribution, using as a control group women from the 75th percentile of the income distribution. I therefore identify the tax effect as the difference between the change in labor supply of women with large tax rate reductions and the change in labor supply of women with small tax rate reductions. I find evidence that the labor supply of high-income, married women increased due to the Tax Reform Act of 1986. The increase in total labor supply of married women at the top of the income distribution (relative to married women at the 75th percentile of the income distribution) implies an elasticity with respect to the after- tax wage of approximately 0.8. At least half of this elasticity is due to labor force participation. Use of a second control group supports the participation response but is inconclusive on the hours of work response.
Article
This paper use income tax return data from 1960 to 2000 to analyze the link between reported incomes and marginal tax rates. Only the top 1% incomes show evidence of behavioral responses to taxation. The data displays striking heterogeneity in the size of responses to tax changes overtime, with no response either short-term or long-term for the very large Kennedy top rate cuts in the early1960s, and striking evidence of responses, at least in the short-term, to the tax changes since the 1980s. The 1980s tax cuts generated a surge in business income reported by high income individual taxpayers due to a shift away from the corporate sector, and the disappearance of business losses for tax avoidance. The Tax Reform Act of 1986 and the recent 1993 tax increase generated large short-term responses of wages and salaries reported by top income earners, most likely due to re-timing in compensation to take advantage of the tax changes. However, it is unlikely that the extraordinary trend upward of the shares of total wages accruing to top wage income earners, which started in the 1970s and accelerated in the 1980s and especially the late 1990s, can be explained solely by the evolution of marginal tax rates.
Article
All modern labour market theories capable of explaining involuntary unemployment as an equilibrium phenomenon imply that increased income tax progressivity reduces unemployment, but they also imply that higher progressivity tends to reduce work effort and labour productivity. This suggests that there may be an optimal degree of tax progressivity where the marginal welfare gain from reduced involuntary unemployment is just offset by the marginal welfare loss from lower productivity. This paper sets up three different simulation models of an imperfect labour market in order to identify the degree of tax progressivity which would maximise the welfare of the representative wage earner. The simulations suggest that the optimal degree of tax progressivity could be substantial and that the welfare gains from tax progressivity could be quite large, although the results are sensitive to the generosity of unemployment benefits and to the after-tax wage elasticity of work effort.
Article
This paper develops a rigorous partial equilibrium analysis of the determinants of margin al welfare cost (MWC) of taxes on labor earnings. It shows that four key parameters interact to determine the magnitude of MWC. Using aggregate data and plausible ranges of values for the parameters, MWC can vary from under 10 percent to more than 300 percent of marginal tax revenue. Intermediate parameter values sugge st MWC is in the 25-50 percent range. However, the more extreme estimates cannot be ruled out on the basis of available evidence, suggesting that MWC cannot yet be Copyright 1987 by American Economic Association.
Article
This Paper estimates the welfare and distributional impact of two types of welfare reform in 14 member countries of the European Union. The reforms are revenue neutral and financed by an overall and uniform increase in marginal tax rates on earnings. The first reform distributes the additional tax revenue uniformly to everybody (traditional welfare) while the second reform distributes tax proceeds uniformly to workers only (in-work benefit). We build a simple model of labour supply encompassing responses to taxes and transfers along both the intensive and extensive margin. We then use EUROMOD to describe current welfare and tax systems in all European Union countries (except Sweden) and use calibrated labour supply elasticities along the intensive and extensive margins to analyse the effects of the two welfare reforms. We quantify the equity-efficiency trade-off for a range of elasticity parameters. In most countries, because of the large existing welfare programs with high phase-out rates, the uniform redistribution policy is, in general, undesirable unless the redistributive tastes of the government are extreme. The in-work benefit reform, on the other hand, is desirable in a very wide set of cases. We discuss the practical policy implications for European welfare policy.
Article
Corruption in the public sector erodes tax compliance and leads to higher tax evasion. Moreover, corrupt public officials abuse their public power to extort bribes from the private agents. In both types of interaction with the public sector, the private agents are bound to face uncertainty with respect to their disposable incomes. To analyse effects of this uncertainty, a stochastic dynamic growth model with the public sector is examined. It is shown that deterministic excessive red tape and corruption deteriorate the growth potential through income redistribution and public sector inefficiencies. Most importantly, it is demonstrated that the increase in corruption via higher uncertainty exerts adverse effects on capital accumulation, thus leading to lower growth rates.
Article
Although the standard neoclassical model of female labour supply behaviour usually allows for the impact of demographic changes on value of female time in the household, the complexities of the tax and benefit system, and the influence of saving and borrowing on current period decisions, it does not allow for the possibility of involuntary unemployment. Women who are not working, that is, those who supply zero hours of labour, are assumed to do so voluntarily; the model does not allow for women who are not currently in employment and wanting to work but unable to obtain employment. This paper is an attempt to gauge how much the conclusions derived from the standard analysis of labour supply may have to be altered when we allow for such 'unemployed' workers. For the sample of married women in the UK which we investigate, the standard model appears to exaggerate the positive impact which reductions in marginal wages may have on participation and reduces the possibilities for a backward-bending supply curve of labour. The probability of being in a state of unemployment, as defined above, is found to depend on certain demand-side factors, age and a number of other demographic characteristics.
Danske resultater om sammenhaengen mellem marginalskat og løn
  • C T Hansen
  • L H Pedersen
  • T Sløk
Hansen, C.T., L.H. Pedersen, and T. Sløk. (1996). " Danske resultater om sammenhaengen mellem marginalskat og løn. " Nationaløkonomisk Tidsskrift 134, 153-174.
  • A B Krueger
  • B D Meyer Alan
Krueger, A.B. and B.D. Meyer (2002). " Labor Supply Effects of Social Insurance, " in Alan