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If Labor is Inelastic, Are Taxes Still Distorting?

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  • Don Fullerton

Abstract

Three recent papers measure the marginal excess burden of labor taxes in the United States. They obtain very different results even where they all use a zero uncompensated labor supply elasticity and assume that the additional revenue is spent on a public good that is separable in utility. The impression is that other parameters must explain the differences in results. Yet each paper uses a different concept of excess burden. Here, I calculate all three measures in one model and show how conceptual differences explain the results. Only one of these measures isolates the distortionary effects of taxes in a way that depends on the compensated labor supply elasticity. The other two measures incorporate income effects and thus depend on the actual change in labor. This result was obscured because those papers report positive marginal excess burden even with a zero uncomspensated labor supply elasticity. This paper shows conditions under which their measure is zero, and it interprets the measures in light of recent literature.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 2810.

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Date of creation: Jan 1989
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Publication status: published as "Reconciling Recent Estimates of the Marginal Welfare Cost of Taxation." From The American Economic Review, Vol. 81, No. 1, pp. 302-308, (March 1991)
Handle: RePEc:nbr:nberwo:2810

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  1. Stuart, Charles E, 1984. "Welfare Costs per Dollar of Additional Tax Revenue in the United States," American Economic Review, American Economic Association, American Economic Association, vol. 74(3), pages 352-62, June.
  2. Auerbach, Alan J., 1985. "The theory of excess burden and optimal taxation," Handbook of Public Economics, Elsevier, in: A. J. Auerbach & M. Feldstein (ed.), Handbook of Public Economics, edition 1, volume 1, chapter 2, pages 61-127 Elsevier.
  3. Bizer, David S & Stuart, Charles, 1987. "The Public Finance of a Protective Tariff: The Case of an Oil Import Fee," American Economic Review, American Economic Association, American Economic Association, vol. 77(5), pages 1019-22, December.
  4. Alan J. Auerbach & Harvey S. Rosen, 1980. "Will the Real Excess Burden Please Stand Up? (Or, Seven Measures in Search of a Concept)," NBER Working Papers 0495, National Bureau of Economic Research, Inc.
  5. Ahmed, S. & Croushore. D.D., 1988. "Substitution Effects And The Marginal Welfare Cost Of Taxation," Papers, Pennsylvania State - Department of Economics 5-88-4, Pennsylvania State - Department of Economics.
  6. Triest, Robert K, 1990. "The Relationship between the Marginal Cost of Public Funds and Marginal Excess Burden," American Economic Review, American Economic Association, American Economic Association, vol. 80(3), pages 557-66, June.
  7. Ballard, Charles L., 1990. "Marginal welfare cost calculations : Differential analysis vs. balanced-budget analysis," Journal of Public Economics, Elsevier, Elsevier, vol. 41(2), pages 263-276, March.
  8. King, Mervyn A., 1983. "Welfare analysis of tax reforms using household data," Journal of Public Economics, Elsevier, Elsevier, vol. 21(2), pages 183-214, July.
  9. Ballard, Charles L & Shoven, John B & Whalley, John, 1985. "General Equilibrium Computations of the Marginal Welfare Costs of Taxes in the United States," American Economic Review, American Economic Association, American Economic Association, vol. 75(1), pages 128-38, March.
  10. Hicks, J. R., 1986. "A Revision of Demand Theory," OUP Catalogue, Oxford University Press, Oxford University Press, number 9780198285502, October.
  11. Diamond, P. A. & McFadden, D. L., 1974. "Some uses of the expenditure function in public finance," Journal of Public Economics, Elsevier, Elsevier, vol. 3(1), pages 3-21, February.
  12. Browning, Edgar K, 1987. "On the Marginal Welfare Cost of Taxation," American Economic Review, American Economic Association, American Economic Association, vol. 77(1), pages 11-23, March.
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Cited by:
  1. Louis Kaplow, 1989. "Optimal Taxation with Costly Enforcement and Evasion," NBER Working Papers 2996, National Bureau of Economic Research, Inc.
  2. Charles L. Ballard & Don Fullerton, 1992. "Distortionary Taxes and the Provision of Public Goods," Journal of Economic Perspectives, American Economic Association, American Economic Association, vol. 6(3), pages 117-131, Summer.
  3. Jonathan Gruber, 2000. "Disability Insurance Benefits and Labor Supply," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 108(6), pages 1162-1183, December.

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