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Labour Supply and Income Tax Changes: A Simulation Study for Finland

  • Kuismanen, Mika


    (Bank of Finland Research)

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    It is well known that estimation of the labour supply function is complicated by the non-linearity of the individual’s budget constraint. Non-linearity may be caused by a number of factors such as the structure of the tax/benefit scheme or overtime rates. Non-linearities also cause problems in interpreting the policy implications of the estimates. In this study we use a well-structured econometric labour supply model that mimics actual budget constraints as closely as possible to analyse the labour-supply effects of different income tax regimes and systems. In addition to the empirically-specified labour supply model, we construct, for the first time in Finland, a behavioural microsimulation model. Our intent is to contribute to the tax debate in Finland by simulating several suggested changes in the tax system. Our simulation results show that none of the proposed reforms are self-financing. Revenue-neutral move to a proportional tax system does not have major effects on labour supply. The most pronounced behavioural effects are achieved when marginal tax rates are reduced at the lower end of the income tax schedule.

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    Paper provided by Bank of Finland in its series Research Discussion Papers with number 5/2000.

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    Length: 39 pages
    Date of creation: 15 Jun 2000
    Date of revision:
    Handle: RePEc:hhs:bofrdp:2000_005
    Contact details of provider: Postal: Bank of Finland, P.O. Box 160, FI-00101 Helsinki, Finland
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    1. Hausman, Jerry A, 1985. "The Econometrics of Nonlinear Budget Sets," Econometrica, Econometric Society, vol. 53(6), pages 1255-82, November.
    2. Richard Blundell & Thomas MaCurdy, 1998. "Labour supply: a review of alternative approaches," IFS Working Papers W98/18, Institute for Fiscal Studies.
    3. Blundell, Richard & Ham, John & Meghir, Costas, 1987. "Unemployment and Female Labour Supply," Economic Journal, Royal Economic Society, vol. 97(388a), pages 44-64, Supplemen.
    4. Tuomala, Matti, 1990. "Optimal Income Tax and Redistribution," OUP Catalogue, Oxford University Press, number 9780198286059.
    5. Blundell, Richard William & Meghir, Costas, 1985. "Selection Criteria for a Microeconometric Model of Labour Supply," CEPR Discussion Papers 57, C.E.P.R. Discussion Papers.
    6. Blundell, Richard & Walker, Ian, 1986. "A Life-Cycle Consistent Empirical Model of Family Labour Supply Using Cross-Section Data," Review of Economic Studies, Wiley Blackwell, vol. 53(4), pages 539-58, August.
    7. Hausman, Jerry A, 1981. "Exact Consumer's Surplus and Deadweight Loss," American Economic Review, American Economic Association, vol. 71(4), pages 662-76, September.
    8. Blundell, Richard & Meghir, Costas & Symons, Elizabeth & Walker, Ian, 1988. "Labour supply specification and the evaluation of tax reforms," Journal of Public Economics, Elsevier, vol. 36(1), pages 23-52, June.
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