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The Marginal Cost of Public Funds: Hours of Work versus Labor Force Participation

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Author Info
Kleven, Henrik
Kreiner, Claus Thustrup
Abstract

This paper extends the theory and measurement of the marginal cost of public funds (MCF) to account for labour force participation responses. Our work is motivated by the emerging consensus in the empirical literature that extensive (participation) responses are more important than intensive (hours-of-work) responses. In the modelling of extensive responses, we argue that it is crucial to account for the presence of non-convexities created by fixed costs of work. In a non-convex framework, tax and transfer reforms give rise to discrete participation responses generating first-order effects on government revenue and the marginal cost of funds. Based on analytical expressions accounting for both margins of labour supply response, and allowing for heterogeneity in productivities and preferences, we calculate MCF for 15 European countries using micro data on taxes and benefits for each country. The MCF estimates depend crucially on the country under consideration and on the properties of the tax reform. In general, we find that extensive responses have very important effects on MCF, especially in the Scandinavian and the Central/Northern Continental European countries where participation tax rates are very high at the bottom of the distribution resulting from generous out-of-work benefits along with high tax rates on workers. For these countries, the estimated MCFs centre around 2 in the case of proportional tax changes.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 5594.

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Date of creation: Mar 2006
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Related research
Keywords: fixed work costs; income transfers; intensive and extensive responses; labour supply; marginal welfare costs; taxation;

Find related papers by JEL classification:
H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation
H41 - Public Economics - - Publicly Provided Goods - - - Public Goods
J20 - Labor and Demographic Economics - - Demand and Supply of Labor - - - General

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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Keuschnigg, Christian, 2006. "Exports, Foreign Direct Investment and the Costs of Coporate Taxation," CEPR Discussion Papers 5769, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
    Other versions:
  2. Kenneth A. Small, 2009. "Private Provision of Highways: Economic Issues," Working Papers 080917, University of California-Irvine, Department of Economics. [Downloadable!]
  3. Claus Thustrup Kreiner & Nicolaj Verdelin, 2009. "Optimal Provision of Public Goods: A Synthesis," CESifo Working Paper Series CESifo Working Paper No. , CESifo Group Munich. [Downloadable!]
  4. Christian Keuschnigg, 2006. "Extensive and Intensive Investment and the Dead Weight Loss of Corporate Taxation," University of St. Gallen Department of Economics working paper series 2006 2006-16, Department of Economics, University of St. Gallen. [Downloadable!]
  5. Karsten Staehr, 2008. "Estimates of employment and welfare effects of personal labour income taxation in a flat-tax country : The case of Estonia," Bank of Estonia Working Papers 2008-03, Bank of Estonia, revised 30 Oct 2008. [Downloadable!]
  6. Louis Lévy-Garboua & David Masclet & Claude Montmarquette, 2008. "A Behavioral Laffer Curve: Emergence of a Social Norm of Fairness in a Real Effort Experiment," Université Paris1 Panthéon-Sorbonne (Post-Print and Working Papers) hal-00340459_v1, HAL. [Downloadable!]
    Other versions:
  7. Claus Thustrup Kreiner & Nicolaj Verdelin, 2008. "Optimal Provision of Public Goods: A Synthesis," EPRU Working Paper Series 08-05, Economic Policy Research Unit (EPRU), University of Copenhagen. Department of Economics. [Downloadable!]
  8. Lars Calmfors & Giancarlo Corsetti & Michael P. Devereux & Gilles Saint-Paul & Hans-Werner Sinn & Jan-Egbert Sturm & Xavier Vives, 2008. "Chapter 4: Industrial policy," EEAG Report on the European Economy, CESifo Group Munich, vol. 0, pages 105-124, 02. [Downloadable!]
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