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Optimal Income Transfer Programs: Intensive Versus Extensive Labor Supply Responses

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  • Emmanuel Saez

Abstract

This paper investigates the optimal income transfer problem at the low end of the income distribution. The government maximizes a social welfare function and faces the traditional equity-efficiency trade-off. The paper models labor supply behavioral responses along the intensive margin (hours or intensity of work on the job) and along the extensive margin (participation in the labor force). Optimal tax formulas are derived as a function of the behavioral elasticities, the shape of the income distribution and the redistribution tastes of the government. When behavioral responses are concentrated along the intensive margin, the optimal transfer program is a classical Negative Income Tax program with a substantial guaranteed income support that is taxed away at high rates. However, when behavioral responses are concentrated along the extensive margin, the optimal transfer program is an Earned Income Credit program with negative marginal tax rates at low income levels and a small guaranteed income. Numerical simulations calibrated with the actual empirical earnings distribution are presented for a range of behavioral elasticities and redistributive tastes of the government. For realistic elasticities, the optimal program provides a moderate guaranteed income, imposes low tax rates on very low annual earnings levels, and then starts phasing out benefits at substantial rates.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 7708.

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Date of creation: May 2000
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Publication status: published as Saez, Emmanuel. "Optimal Income Transfer Programs: Intensive Versus Extensive Labor Supply Responses," Quarterly Journal of Economics, 2002, v107(3,Aug), 1039-1073.
Handle: RePEc:nbr:nberwo:7708

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  1. Nada Eissa & Hilary Williamson Hoynes, 2000. "The Earned Income Tax Credit and the Labor Supply of Married Couples," Public Economics 9912001, EconWPA.
  2. Ravi Kanbur & Michael Keen & Matti Tuomala, 1990. "Optimal Non-Linear Income Taxation for the Alleviation of Income Poverty," Working Papers 799, Queen's University, Department of Economics.
  3. Bruce D. Meyer & Dan T. Rosenbaum, 2001. "Welfare, The Earned Income Tax Credit, And The Labor Supply Of Single Mothers," The Quarterly Journal of Economics, MIT Press, vol. 116(3), pages 1063-1114, August.
  4. Richard Blundell & Thomas MaCurdy, 1998. "Labour supply: a review of alternative approaches," IFS Working Papers W98/18, Institute for Fiscal Studies.
  5. Jon Gruber & Emmanuel Saez, 2000. "The Elasticity of Taxable Income: Evidence and Implications," NBER Working Papers 7512, National Bureau of Economic Research, Inc.
  6. Rebecca M. Blank & David Card & Philip K. Robins, 1999. "Financial Incentives for Increasing Work and Income Among Low- Income Families," HEW 9902002, EconWPA.
  7. David Card & Philip K. Robins, 1996. "Do Financial Incentives Encourage Welfare Recipients to Work? Evidence from a Randomized Evaluation of the Self-Sufficiency Project," NBER Working Papers 5701, National Bureau of Economic Research, Inc.
  8. Emmanuel Saez, 2000. "Using Elasticities to Derive Optimal Income Tax Rates," NBER Working Papers 7628, National Bureau of Economic Research, Inc.
  9. P. Diamond & J. Helms & J. Mirrlees, 1978. "Optimal Taxation in a Stochastic Economy: A Cobb-Douglas Example," Working papers 217, Massachusetts Institute of Technology (MIT), Department of Economics.
  10. Eissa, Nada & Liebman, Jeffrey B, 1996. "Labor Supply Response to the Earned Income Tax Credit," The Quarterly Journal of Economics, MIT Press, vol. 111(2), pages 605-37, May.
  11. Philip K. Robins, 1985. "A Comparison of the Labor Supply Findings from the Four Negative Income Tax Experiments," Journal of Human Resources, University of Wisconsin Press, vol. 20(4), pages 567-582.
  12. Zeckhauser, Richard J, 1971. "Optimal Mechanisms for Income Transfer," American Economic Review, American Economic Association, vol. 61(3), pages 324-34, June.
  13. Danziger, Sheldon & Haveman, Robert & Plotnick, Robert, 1981. "How Income Transfer Programs Affect Work, Savings, and the Income Distribution: A Critical Review," Journal of Economic Literature, American Economic Association, vol. 19(3), pages 975-1028, September.
  14. Diamond, P. A. & Mirrlees, J. A., 1978. "A model of social insurance with variable retirement," Journal of Public Economics, Elsevier, vol. 10(3), pages 295-336, December.
  15. Mirrlees, James A, 1971. "An Exploration in the Theory of Optimum Income Taxation," Review of Economic Studies, Wiley Blackwell, vol. 38(114), pages 175-208, April.
  16. Mirrlees, J. A., 1982. "Migration and optimal income taxes," Journal of Public Economics, Elsevier, vol. 18(3), pages 319-341, August.
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