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Income Taxation in a Life Cycle Model with Human Capital

  • Michael P. Keane

    ()

    (Nuffield College, University of Oxford)

I examine the effect of labor income taxation in life-cycle models where work experience builds human capital. In this case, the wage no longer equals the opportunity cost of time – which is, instead, the wage plus returns to work experience. This has a number of interesting consequences. First, the data appear consistent with much larger labor supply elasticities than most prior work suggests. Second, again contrary to conventional wisdom, permanent tax changes can have larger effects on current labor supply than temporary tax changes. Third, human capital amplifies the labor supply response to permanent tax changes in the long-run, as a permanent tax reduces the rate of human capital accumulation (reducing worker productivity). Fourth, for plausible parameter values, welfare losses from proportional income taxation are likely to be much larger than conventional wisdom suggests.

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File URL: http://www.nuffield.ox.ac.uk/economics/papers/2012/Taxes_HC_42_Nuffield.pdf
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Paper provided by Economics Group, Nuffield College, University of Oxford in its series Economics Papers with number 2012-W08.

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Length: 41 pages
Date of creation: 15 Oct 2012
Date of revision:
Handle: RePEc:nuf:econwp:1208
Contact details of provider: Web page: http://www.nuff.ox.ac.uk/economics/

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  1. MaCurdy, Thomas E, 1981. "An Empirical Model of Labor Supply in a Life-Cycle Setting," Journal of Political Economy, University of Chicago Press, vol. 89(6), pages 1059-85, December.
  2. Rogerson, Richard & Wallenius, Johanna, 2009. "Micro and macro elasticities in a life cycle model with taxes," Journal of Economic Theory, Elsevier, vol. 144(6), pages 2277-2292, November.
  3. Michael Keane, 2010. "Labor Supply and Taxes: A Survey," Working Paper Series 160, Finance Discipline Group, UTS Business School, University of Technology, Sydney.
  4. Patrick Bajari & Ali Hortacsu, 2003. "Are Structural Estimates of Auction Models Reasonable? Evidence from Experimental Data," NBER Working Papers 9889, National Bureau of Economic Research, Inc.
  5. Susumu Imai & Michael P. Keane, 2004. "Intertemporal Labor Supply and Human Capital Accumulation," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 45(2), pages 601-641, 05.
  6. Prescott, Edward C., 1986. "Theory ahead of business-cycle measurement," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 25(1), pages 11-44, January.
  7. Michael Keane & Richard Rogers, 2012. "Reconciling Micro and Macro Labor Supply Elasticities: A Structural Perspective," Economics Series Working Papers 2012-W12, University of Oxford, Department of Economics.
  8. Shaw, Kathryn L, 1989. "Life-Cycle Labor Supply with Human Capital Accumulation," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 30(2), pages 431-56, May.
  9. Charles L. Ballard & Don Fullerton, 1990. "Distortionary Taxes and the Provision of Public Goods," NBER Working Papers 3506, National Bureau of Economic Research, Inc.
  10. Michael P. Keane & Kenneth I. Wolpin, 1995. "The career decisions of young men," Working Papers 559, Federal Reserve Bank of Minneapolis.
  11. Eric French, 2004. "The Effects of Health, Wealth and Wages on Labor Supply and Retirement Behavior," 2004 Meeting Papers 96, Society for Economic Dynamics.
  12. James J. Heckman, 1976. "Estimates of a Human Capital Production Function Embedded in a Life-Cycle Model of Labor Supply," NBER Chapters, in: Household Production and Consumption, pages 225-264 National Bureau of Economic Research, Inc.
  13. Richard Blundell & Thomas MaCurdy, 1998. "Labour supply: a review of alternative approaches," IFS Working Papers W98/18, Institute for Fiscal Studies.
  14. Michael P. Keane & Kenneth I. Wolpin, 2010. "The Role Of Labor And Marriage Markets, Preference Heterogeneity, And The Welfare System In The Life Cycle Decisions Of Black, Hispanic, And White Women," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 51(3), pages 851-892, 08.
  15. David Domeij & Martin Floden, 2006. "The Labor-Supply Elasticity and Borrowing Constraints: Why Estimates are Biased," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 9(2), pages 242-262, April.
  16. Keane, Michael P & Wolpin, Kenneth I, 2001. "The Effect of Parental Transfers and Borrowing Constraints on Educational Attainment," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 42(4), pages 1051-1103, November.
  17. Low, Hamish & Maldoom, Daniel, 2004. "Optimal taxation, prudence and risk-sharing," Journal of Public Economics, Elsevier, vol. 88(3-4), pages 443-464, March.
  18. Saez, Emmanuel, 2001. "Using Elasticities to Derive Optimal Income Tax Rates," Review of Economic Studies, Wiley Blackwell, vol. 68(1), pages 205-29, January.
  19. Sheshinski, Eytan, 1972. "The Optimal Linear Income-Tax," Review of Economic Studies, Wiley Blackwell, vol. 39(3), pages 297-302, July.
  20. van der Klaauw, Wilbert & Wolpin, Kenneth I., 2008. "Social security and the retirement and savings behavior of low-income households," Journal of Econometrics, Elsevier, vol. 145(1-2), pages 21-42, July.
  21. Keane, Michael P & Wolpin, Kenneth I, 2000. "Eliminating Race Differences in School Attainment and Labor Market Success," Journal of Labor Economics, University of Chicago Press, vol. 18(4), pages 614-52, October.
  22. Kimmel, Jean & Kniesner, Thomas J., 1998. "New evidence on labor supply:: Employment versus hours elasticities by sex and marital status," Journal of Monetary Economics, Elsevier, vol. 42(2), pages 289-301, July.
  23. repec:bla:restud:v:72:y:2005:i:2:p:395-427 is not listed on IDEAS
  24. Geweke, John & Keane, Michael, 2000. "An empirical analysis of earnings dynamics among men in the PSID: 1968-1989," Journal of Econometrics, Elsevier, vol. 96(2), pages 293-356, June.
  25. Edward C. Prescott, 2006. "Nobel Lecture: The Transformation of Macroeconomic Policy and Research," Journal of Political Economy, University of Chicago Press, vol. 114(2), pages 203-235, April.
  26. Emmanuel Saez & Joel B. Slemrod & Seth H. Giertz, 2009. "The Elasticity of Taxable Income with Respect to Marginal Tax Rates: A Critical Review," NBER Working Papers 15012, National Bureau of Economic Research, Inc.
  27. Goeree, Jacob K. & Holt, Charles A. & Palfrey, Thomas R., 2003. "Risk averse behavior in generalized matching pennies games," Games and Economic Behavior, Elsevier, vol. 45(1), pages 97-113, October.
  28. Ellen R. McGrattan & Richard Rogerson, 1998. "Changes in hours worked since 1950," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win, pages 2-19.
  29. Heckman, James J & MaCurdy, Thomas, 1982. "Corrigendum on a Life Cycle Model of Female Labour Supply," Review of Economic Studies, Wiley Blackwell, vol. 49(4), pages 659-60, October.
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