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Taxes and Employment Subsidies in Optimal Redistribution Programs (Revised Version)

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Author Info

  • Beaudry, Paul

    (University of British Columbia, and NBER.)

  • Blackorby, Charles

    (University of Warwick and GREQAM)

  • Szalay, Dezso

    (University of Warwick)

Abstract

This paper explores how to optimally set tax and transfers when taxation authorities : (1) are uninformed about individuals’ value of time in both market and non-market activities and (2) can observe both market-income and time allocated to market employment. We show that optimal redistribution in this environment involves distorting market employment upwards for low wage individuals through decreasing wage-contingent employment subsidies, and distorting employment downwards for high wage individuals through positive and increasing marginal income tax rates. In particular, we show that whether a person is taxed or subsidized depends primarily on his wage, that is, the optimal program involves a cut-off wage whereby workers above the cutoff are taxed as they increase their income, while workers earning a wage below the cutoff receive an income supplement (an earned income tax credit) as they increase their income. Finally, we show that the optimal program transfers zero income to individuals who choose not to work.

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Bibliographic Info

Paper provided by University of Warwick, Department of Economics in its series The Warwick Economics Research Paper Series (TWERPS) with number 779.

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Length: 37 pages
Date of creation: 2006
Date of revision:
Handle: RePEc:wrk:warwec:779

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Keywords: Taxation ; Redistribution ; Wage Subsidies Screening;

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References

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  1. Paul Beaudry & Charles Blackorby & Dezs� Szalay, 2009. "Taxes and Employment Subsidies in Optimal Redistribution Programs," American Economic Review, American Economic Association, American Economic Association, vol. 99(1), pages 216-42, March.
  2. Katherine Cuff, 2000. "Optimality of workfare with heterogeneous preferences," Canadian Journal of Economics, Canadian Economics Association, Canadian Economics Association, vol. 33(1), pages 149-174, February.
  3. Chone, Philippe & Laroque, Guy, 2005. "Optimal incentives for labor force participation," Journal of Public Economics, Elsevier, Elsevier, vol. 89(2-3), pages 395-425, February.
  4. Mirrlees, James A, 1997. "Information and Incentives: The Economics of Carrots and Sticks," Economic Journal, Royal Economic Society, Royal Economic Society, vol. 107(444), pages 1311-29, September.
  5. Guy Laroque, 2005. "Income Maintenance and Labor Force Participation," Econometrica, Econometric Society, Econometric Society, vol. 73(2), pages 341-376, 03.
  6. Kanbur, Ravi & Keen, Michael & Tuomala, Matti, 1994. "Optimal non-linear income taxation for the alleviation of income-poverty," European Economic Review, Elsevier, Elsevier, vol. 38(8), pages 1613-1632, October.
  7. Maskin, Eric & Riley, John, 1985. "Input versus output incentive schemes," Journal of Public Economics, Elsevier, Elsevier, vol. 28(1), pages 1-23, October.
  8. Jonathan R. Kesselman, 1977. "Tax Instruments and Economic Equality," Canadian Journal of Economics, Canadian Economics Association, Canadian Economics Association, vol. 10(2), pages 289-99, May.
  9. Jullien, Bruno, 2000. "Participation Constraints in Adverse Selection Models," Journal of Economic Theory, Elsevier, Elsevier, vol. 93(1), pages 1-47, July.
  10. Matthews, Steven & Moore, John, 1987. "Monopoly Provision of Quality and Warranties: An Exploration in the Theory of Multidimensional Screening," Econometrica, Econometric Society, Econometric Society, vol. 55(2), pages 441-67, March.
  11. Maderner, Nina & Rochet, Jean-Charles, 1995. " Is It Legitimate to Encourage Work Sharing?," Scandinavian Journal of Economics, Wiley Blackwell, Wiley Blackwell, vol. 97(4), pages 621-33, December.
  12. Marceau, Nicolas & Boadway, Robin, 1994. " Minimum Wage Legislation and Unemployment Insurance as Instruments for Redistribution," Scandinavian Journal of Economics, Wiley Blackwell, Wiley Blackwell, vol. 96(1), pages 67-81.
  13. Armstrong, Mark, 1996. "Multiproduct Nonlinear Pricing," Econometrica, Econometric Society, Econometric Society, vol. 64(1), pages 51-75, January.
  14. David Card & Philip Robins, 1996. "Do Financial Incentives Encourage Welfare Recipients to Work? Early Findings from the Canadian Self Sufficiency Project," Working Papers, Princeton University, Department of Economics, Industrial Relations Section. 738, Princeton University, Department of Economics, Industrial Relations Section..
  15. Brett, Craig, 1998. "Who Should Be on Workfare? The Use of Work Requirements as Part of an Optimal Tax Mix," Oxford Economic Papers, Oxford University Press, vol. 50(4), pages 607-22, October.
  16. Besley, Timothy & Coate, Stephen, 1995. "The Design of Income Maintenance Programmes," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 62(2), pages 187-221, April.
  17. Kesselman, Jonathan R., 1973. "A comprehensive approach to income maintenance: swift," Journal of Public Economics, Elsevier, Elsevier, vol. 2(1), pages 59-88, February.
  18. Philippe Choné & Guy Laroque, 2006. "Should Low Skilled Work be Subsidized ?," Working Papers, Centre de Recherche en Economie et Statistique 2006-08, Centre de Recherche en Economie et Statistique.
  19. Dasgupta, Partha & Hammond, Peter, 1980. "Fully progressive taxation," Journal of Public Economics, Elsevier, Elsevier, vol. 13(2), pages 141-154, April.
  20. Diamond, P., 1980. "Income taxation with fixed hours of work," Journal of Public Economics, Elsevier, Elsevier, vol. 13(1), pages 101-110, February.
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Cited by:
  1. Murty, Sushama, 2006. "Externalities and Fundamental Nonconvexities : A Reconciliation of Approaches to General Equilibrium Externality Modelling and Implications for Decentralization," The Warwick Economics Research Paper Series (TWERPS), University of Warwick, Department of Economics 756, University of Warwick, Department of Economics.
  2. Richard Blundell & Andrew Shephard, 2008. "Employment, hours of work and the optimal taxation of low income families," IFS Working Papers, Institute for Fiscal Studies W08/01, Institute for Fiscal Studies.
  3. Blackorby, Charles & Szalay, Dezsö, 2008. "Regulating a Monopolist with unknown costs and unknown quality capacity," The Warwick Economics Research Paper Series (TWERPS), University of Warwick, Department of Economics 858, University of Warwick, Department of Economics.

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