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Employment, hours of work and the optimal taxation of low income families

  • Richard Blundell


    (Institute for Fiscal Studies and IFS and UCL)

  • Andrew Shephard


    (Institute for Fiscal Studies and University of Pennsylvania)

This paper examines the tax schedule for low income families with children. We take an optimal tax approach based on a structural labour supply model which incorporates unobserved heterogeneity, fixed costs of work, childcare costs and the detailed non-convexities of the tax and transfer system. The motivation is the British earned income tax credit reform (WFTC) and its interaction with the tax and transfer system for lone parents. Our analysis also examines the case for the use of hours-contingent payments. The results point to a tax schedule which depends on the age of children, with tax credits only optimal for low earners with school age children. The results also suggest a welfare improving role for hours-contingent payments although this is mitigated when hours cannot be monitored or recorded accurately by the tax authorities.

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Paper provided by Institute for Fiscal Studies in its series IFS Working Papers with number W08/01.

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Length: 59 pp.
Date of creation: Jan 2008
Date of revision:
Handle: RePEc:ifs:ifsewp:08/01
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  1. John Creedy & Guyonne Kalb, 2003. "Discrete Hours Labour Supply Modelling: Specification, Estimation and Simulation," Treasury Working Paper Series 03/20, New Zealand Treasury.
  2. Nada Eissa & Jeffrey B. Liebman, 1995. "Labor Supply Response to the Earned Income Tax Credit," NBER Working Papers 5158, National Bureau of Economic Research, Inc.
  3. van Soest, A.H.O. & Das, J.W.M. & Gong, X., 2001. "A Structural Labour Supply Model with Flexible Preferences," Other publications TiSEM 07a46b83-f128-4ea5-8498-9, Tilburg University, School of Economics and Management.
  4. Phelps, Edmund S, 1994. "Low-Wage Employment Subsidies versus the Welfare State," American Economic Review, American Economic Association, vol. 84(2), pages 54-58, May.
  5. Rolf Aaberge & Ugo Colombino, 2006. "Designing Optimal Taxes with a Microeconometric Model of Household Labour Supply," ICER Working Papers 37-2006, ICER - International Centre for Economic Research.
  6. Dickens, Richard & Ellwood, David T., 2001. "Whither Poverty in Great Britain and the United States? The Determinants of Changing Poverty and Whether Work Will Work," Working Paper Series rwp01-010, Harvard University, John F. Kennedy School of Government.
  7. Beaudry, Paul & Blackorby, Charles & Szalay, Dezso, 2006. "Taxes and Employment Subsidies in Optimal Redistribution Programs (Revised Version)," The Warwick Economics Research Paper Series (TWERPS) 779, University of Warwick, Department of Economics.
  8. Jon Gruber & Emmanuel Saez, 2000. "The Elasticity of Taxable Income: Evidence and Implications," NBER Working Papers 7512, National Bureau of Economic Research, Inc.
  9. M. Keane & R. Mofitt, 1995. "A Structural Model of Multiple Welfare Program Participation and Labor Supply," Working Papers 95-4, Brown University, Department of Economics.
  10. Brewer, Mike & Duncan, Alan & Shephard, Andrew & Suarez, Maria Jose, 2006. "Did working families' tax credit work? The impact of in-work support on labour supply in Great Britain," Labour Economics, Elsevier, vol. 13(6), pages 699-720, December.
  11. Richard Blundell & Thomas MaCurdy, 1998. "Labour supply: a review of alternative approaches," IFS Working Papers W98/18, Institute for Fiscal Studies.
  12. Hilary Hoynes, 1993. "Welfare Transfers in Two-Parent Families: Labor Supply and Welfare Participation Under AFDC-UP," NBER Working Papers 4407, National Bureau of Economic Research, Inc.
  13. Saez, Emmanuel, 2001. "Using Elasticities to Derive Optimal Income Tax Rates," Review of Economic Studies, Wiley Blackwell, vol. 68(1), pages 205-29, January.
  14. Train,Kenneth E., 2009. "Discrete Choice Methods with Simulation," Cambridge Books, Cambridge University Press, number 9780521747387.
  15. Paul Beaudry & Charles Blackorby, 1998. "Taxes and Employment Subsidies in Optimal Redistribution Programs," NBER Working Papers 6355, National Bureau of Economic Research, Inc.
  16. 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.
  17. Herwig Immervoll & Henrik Jacobsen Kleven & Claus Thustrup Kreiner & Emmanuel Saez, 2007. "Welfare reform in European countries: a microsimulation analysis," Economic Journal, Royal Economic Society, vol. 117(516), pages 1-44, 01.
  18. Richard Blundell & Monica Costa Dias, 2000. "Evaluation methods for non-experimental data," Fiscal Studies, Institute for Fiscal Studies, vol. 21(4), pages 427-468, January.
  19. Guy Laroque, 2005. "Income Maintenance and Labor Force Participation," Econometrica, Econometric Society, vol. 73(2), pages 341-376, 03.
  20. Austan Goolsbee, 1997. "What Happens When You Tax the Rich? Evidence from Executive Compensation," NBER Working Papers 6333, National Bureau of Economic Research, Inc.
  21. Besley, Timothy & Coate, Stephen, 1992. "Workfare versus Welfare Incentive Arguments for Work Requirements in Poverty-Alleviation Programs," American Economic Review, American Economic Association, vol. 82(1), pages 249-61, March.
  22. Cogan, John F, 1981. "Fixed Costs and Labor Supply," Econometrica, Econometric Society, vol. 49(4), pages 945-63, June.
  23. Moffitt, Robert, 1983. "An Economic Model of Welfare Stigma," American Economic Review, American Economic Association, vol. 73(5), pages 1023-35, December.
  24. Diamond, P., 1980. "Income taxation with fixed hours of work," Journal of Public Economics, Elsevier, vol. 13(1), pages 101-110, February.
  25. Chone, Philippe & Laroque, Guy, 2005. "Optimal incentives for labor force participation," Journal of Public Economics, Elsevier, vol. 89(2-3), pages 395-425, February.
  26. Mike Brewer, 2001. "Comparing in-work benefits and the reward to work for families with children in the US and the UK," Fiscal Studies, Institute for Fiscal Studies, vol. 22(1), pages 41-77, January.
  27. Kelly Bishop & Bradley Heim & Kata Mihaly, 2009. "Single Women's Labor Supply Elasticities: Trends and Policy Implications," Industrial and Labor Relations Review, ILR Review, Cornell University, ILR School, vol. 63(1), pages 146, October.
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