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Discreteness and the Welfare Cost of Labour Supply Tax Distortions

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Abstract

We compare the welfare costs of tax distortions of labour supply in one and two member household discrete and continuous labour supply (leisure consumption) choice models. In the discrete models taxes induce a large response from a subset of the population, while the majority of the population exhibits unchanged behaviour. In contrast the majority of the population reacts to tax changes in continuous models. Models are made comparable by calibrating to the same aggregate uncompensated labour supply elasticities in discrete and continuous models. The welfare costs of similar taxes are significantly different when individuals face discrete labour supply choices than when they choose working hours continuously, and vary with tax rates in different ways. Analysis of results from these models show that discrete choice matters in the assessment of the costs of labour supply tax distortions.

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Paper provided by University of Western Ontario, Department of Economics in its series UWO Department of Economics Working Papers with number 20023.

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Date of creation: May 2002
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Handle: RePEc:uwo:uwowop:20023

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Postal: Department of Economics, Reference Centre, Social Science Centre, University of Western Ontario, London, Ontario, Canada N6A 5C2
Phone: 519-661-2111 Ext.85244
Web page: http://economics.uwo.ca/research/research_papers/department_working_papers.html

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Keywords: Discreteness; labour supply; welfare; taxes; equilibrium;

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  1. Piggott, John & Whalley, John, 1996. "The Tax Unit and Household Production," Journal of Political Economy, University of Chicago Press, vol. 104(2), pages 398-418, April.
  2. Kahn, Shulamit & Lang, Kevin, 1991. "The Effect of Hours Constraints on Labor Supply Estimates," The Review of Economics and Statistics, MIT Press, vol. 73(4), pages 605-11, November.
  3. William T. Dickens & Shelly J. Lundberg, 1985. "Hours Restrictions and Labor Supply," NBER Working Papers 1638, National Bureau of Economic Research, Inc.
  4. Cogan, John F, 1981. "Fixed Costs and Labor Supply," Econometrica, Econometric Society, vol. 49(4), pages 945-63, June.
  5. Richard Blundell, 1992. "Labour supply and taxation: a survey," Fiscal Studies, Institute for Fiscal Studies, vol. 13(3), pages 15-40, January.
  6. Gary Hansen, 2010. "Indivisible Labor and the Business Cycle," Levine's Working Paper Archive 233, David K. Levine.
  7. Stewart, M.B. & Swaffield, J.K., 1996. "Constraints on the Desired Hours of Work of British Men," The Warwick Economics Research Paper Series (TWERPS) 468, University of Warwick, Department of Economics.
  8. Rosen, Harvey S, 1976. "Taxes in a Labor Supply Model with Joint Wage-Hours Determination," Econometrica, Econometric Society, vol. 44(3), pages 485-507, May.
  9. Ian Walker & Ian Preston, 1999. "Welfare measurement in labour supply models with nonlinear budget constraints," Journal of Population Economics, Springer, vol. 12(3), pages 343-361.
  10. Richard Blundell & Thomas MaCurdy, 1998. "Labour supply: a review of alternative approaches," IFS Working Papers W98/18, Institute for Fiscal Studies.
  11. Shoven,John B. & Whalley,John, 1992. "Applying General Equilibrium," Cambridge Books, Cambridge University Press, number 9780521319867.
  12. Thomas MaCurdy & David Green & Harry Paarsch, 1990. "Assessing Empirical Approaches for Analyzing Taxes and Labor Supply," Journal of Human Resources, University of Wisconsin Press, vol. 25(3), pages 415-490.
  13. Martijn P. Tummers & Isolde Woittiez, 1991. "A Simultaneous Wage and Labor Supply Model with Hours Restrictions," Journal of Human Resources, University of Wisconsin Press, vol. 26(3), pages 393-423.
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Cited by:
  1. Vermeulen, F.M.P. & Bargain, O. & Beblo, M. & Beninger, D. & Blundell, R. & Carrasco, R. & Chiuri, M-C. & Laisney, F. & Lechene, V. & Moreau, N. & Myck, M. & Ruiz-castillo, J., 2006. "Collective models of labor supply with nonconvex budget sets and nonparticipation: A calibration approach," Open Access publications from Tilburg University urn:nbn:nl:ui:12-194160, Tilburg University.
  2. Shun-ichiro Bessho & Masayoshi Hayashi, 2005. "The CES utility function, non-linear budget constraints and labor supply : results on prime-age males in Japan," Labor Economics Working Papers 21911, East Asian Bureau of Economic Research.
  3. Olivier Bargain & Nicolas Moreau, 2002. "Is the collective model of labor supply useful for tax policy analysis ? A simulation exercise," DELTA Working Papers 2002-21, DELTA (Ecole normale supérieure).
  4. María Alzúa & Guillermo Cruces & Laura Ripani, 2013. "Welfare programs and labor supply in developing countries: experimental evidence from Latin America," Journal of Population Economics, Springer, vol. 26(4), pages 1255-1284, October.
  5. Parry, Ian & Goulder, Lawrence & Williams III, Roberton, 1997. "When Can Carbon Abatement Policies Increase Welfare? The Fundamental Role of Distorted Factor Markets," Discussion Papers dp-97-18-rev, Resources For the Future.

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