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Discreteness and the Welfare Cost of Labor Supply Tax Distortions

  • Keshab Bhattarai
  • John Whalley

We discuss the role played by discrete labor supply (leisure consumption) choice in" affecting measures of the welfare cost of labor supply tax distortions. We construct comparable" continuous and discrete choice models, each calibrated to have similar aggregate" (uncompensated) labor supply elasticities. In the former, there is a single representative" consumer; in the latter there is a distribution of individuals across preference parameters. In the" discrete model, taxes induce a large response from a subset of the population of the population shows unchanged behavior. Welfare costs of similar taxes in continuous" models can substantially exceed those in discrete models or vice versa formulation used. Experiments are also reported for a two labor type household model with one" continuous variable (secondary labor) and one discrete variable (primary labor) are also made using an empirically based model specification calibrated to UK data. Model" results clearly show that discrete choice matters in the assessment of the cost of labor supply tax" distortions.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 6280.

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Date of creation: Nov 1997
Date of revision:
Publication status: published as Bhattarai, Keshab and John Whalley. "Discreteness And The Welfare Cost Of Labor Supply Tax Distortions," International Economic Review, 2003, v44(3,Aug), 1117-1133.
Handle: RePEc:nbr:nberwo:6280
Note: PE
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  1. Shoven,John B. & Whalley,John, 1992. "Applying General Equilibrium," Cambridge Books, Cambridge University Press, number 9780521266550, October.
  2. Shulamit Kahn & Kevin Lang, 1988. "The Effects of Hours Constraints on Labor Supply Estimates," NBER Working Papers 2647, National Bureau of Economic Research, Inc.
  3. 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.
  4. William T. Dickens & Shelly J. Lundberg, 1985. "Hours Restrictions and Labor Supply," NBER Working Papers 1638, National Bureau of Economic Research, Inc.
  5. 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.
  6. 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.
  7. 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.
  8. 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.
  9. Richard Blundell, 1992. "Labour supply and taxation: a survey," Fiscal Studies, Institute for Fiscal Studies, vol. 13(3), pages 15-40, January.
  10. Richard Blundell & Thomas MaCurdy, 1998. "Labour supply: a review of alternative approaches," IFS Working Papers W98/18, Institute for Fiscal Studies.
  11. Cogan, John F, 1981. "Fixed Costs and Labor Supply," Econometrica, Econometric Society, vol. 49(4), pages 945-63, June.
  12. 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.
  13. Hansen, Gary D., 1985. "Indivisible labor and the business cycle," Journal of Monetary Economics, Elsevier, vol. 16(3), pages 309-327, November.
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