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On modeling household labor supply with taxation

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Olivier Bargain

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Abstract

Discrete-choice models provide a tractable method and a simple way to represent utility-maximizing labor supply decisions in the presence of highly nonlinear and possibly non-convex budget constraints. Thus, it is not surprising that they are so extensively used for ex-ante evaluation of tax-benefit reforms (see Van Soest, 1995, Hoynes, 1996, or Blundell et al., 2000, among others). The question asked in this paper is whether it is possible and desirable to get still more flexibility by relaxing some of the usual constraints imposed on household preferences and rationality. By embedding the traditional structural approach in a more general specification, it is first shown that the restrictions on underlying well-behaved leisure-consumption preferences are rejected. It is often the case that structural models gain some flexibility through additional refinements (e.g. costs of work) whose ad hoc interpretation seems unnecessary. We argue instead for the use of a fully flexible model which remains agnostic on the role of the covariates. More fundamentally still, the standard approach - the assumption of unitary households optimizing statically - is strongly rejected when tested against a general model with price- and income- dependent preferences. In a static environment, this result is a strong rejection of the unitary approach. Restrictions from structural and standard models also imply important discrepancies in the simulated predictions of behavioral responses to a tax reform. This results encourage further effort toward more general approaches including dynamic and collective models.

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Paper provided by DELTA (Ecole normale supérieure) in its series DELTA Working Papers with number 2004-14.

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Date of creation: 2004
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  1. Arntz, Melanie & Boeters, Stefan & Gürtzgen, Nicole & Schubert, Stefanie, 2006. "Analysing welfare reform in a microsimulation-AGE model : the value of disaggregation," ZEW Discussion Papers 06-76, ZEW - Zentrum für Europäische Wirtschaftsforschung / Center for European Economic Research. [Downloadable!]
    Other versions:
  2. François Bourguignon & Amedeo Spadaro, 2005. "Microsimulation as a tool for evaluating redistribution policies," PSE Working Papers 2005-02, PSE (Ecole normale supérieure). [Downloadable!]
    Other versions:
  3. Olivier Bargain & Kristian Orsini, 2004. "In-work policies in Europe: killing two birds with one stone?," DELTA Working Papers 2004-13, DELTA (Ecole normale supérieure). [Downloadable!]
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  4. Michiel Evers & Ruud A. de Mooij & Daniel J. van Vuuren, 2006. "What explains the Variation in Estimates of Labour Supply Elasticities?," Tinbergen Institute Discussion Papers 06-017/3, Tinbergen Institute. [Downloadable!]
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  5. Reto Nyffeler, 2005. "Different Modeling Strategies for Discrete Choice Models of Female Labour Supply: Estimates for Switzerland," Diskussionsschriften dp0508, Universitaet Bern, Departement Volkswirtschaft. [Downloadable!]
  6. Melanie Arntz & Stefan Boeters & Nicole Gürtzgen & Stefanie Schubert, 2006. "Analysing Welfare Reform in a Microsimulation-AGE Model," Computing in Economics and Finance 2006 109, Society for Computational Economics. [Downloadable!]
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