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Regeneration, Labour Supply and the Welfare Costs of Taxes

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  • Edgar Cudmore
  • John Whalley

Abstract

This paper sets out alternatives to the traditional model of labour supply used to analyse the welfare costs of income and/or sales taxes when preferences are defined over goods and leisure and the market wage yields the slope of the budget constraint. The innovation in our work is to assume that some or all of non market time is used to regenerate the productivity of labour through rest and relaxation. This model has no closed form solution, but we can work with the first order conditions numerically for specific functional forms using non linear solution software. We generate a number of alternative parameterizations of this model through a series of calibrations to the same synthetic base case data set. Across the resulting parameterizations the welfare costs of taxes vary substantially (by a factor of twenty fold in some counterfactual analyses), even though they all involve calibration to the same base case data and labour supply elasticity. These results thus suggest that a small and seemingly plausible departure from a standard model (even if not in closed form) that has dominated the economic literature for many years can yield substantial change for perspectives on policy interventions.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 10138.

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Date of creation: Dec 2003
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Handle: RePEc:nbr:nberwo:10138

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  1. Shoven,John B. & Whalley,John, 1992. "Applying General Equilibrium," Cambridge Books, Cambridge University Press, number 9780521319867, April.
  2. Jeff E. Biddle & Daniel S. Hamermesh, 1989. "Sleep and the Allocation of Time," NBER Working Papers 2988, National Bureau of Economic Research, Inc.
  3. James Banks & Richard Blundell & Arthur Lewbel, 1994. "Tax reform and welfare measurement: do we need demand system estimation?," IFS Working Papers W94/11, Institute for Fiscal Studies.
  4. Richard Blundell & Thomas MaCurdy, 1998. "Labour supply: a review of alternative approaches," IFS Working Papers W98/18, Institute for Fiscal Studies.
  5. John C. Ham & Kevin T. Reilly, 2002. "Testing Intertemporal Substitution, Implicit Contracts, and Hours Restriction Models of the Labor Market Using Micro Data," American Economic Review, American Economic Association, vol. 92(4), pages 905-927, September.
  6. Richard Blundell & Alan Duncan & Costas Meghir, 1998. "Estimating Labor Supply Responses Using Tax Reforms," Econometrica, Econometric Society, vol. 66(4), pages 827-862, July.
  7. Jonas D.M. Fisher, 2001. "A real explanation for heterogeneous investment dynamics," Working Paper Series WP-01-14, Federal Reserve Bank of Chicago.
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