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Discreteness and the Welfare Cost of Labour Supply Tax Distortions

We compare the welfare costs of tax distortions of labour supply in one and two member household discrete and continuous labour supply (leisure consumption) choice models. In the discrete models taxes induce a large response from a subset of the population, while the majority of the population exhibits unchanged behaviour. In contrast the majority of the population reacts to tax changes in continuous models. Models are made comparable by calibrating to the same aggregate uncompensated labour supply elasticities in discrete and continuous models. The welfare costs of similar taxes are significantly different when individuals face discrete labour supply choices than when they choose working hours continuously, and vary with tax rates in different ways. Analysis of results from these models show that discrete choice matters in the assessment of the costs of labour supply tax distortions.

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Paper provided by University of Western Ontario, Department of Economics in its series UWO Department of Economics Working Papers with number 20023.

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Date of creation: May 2002
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Handle: RePEc:uwo:uwowop:20023
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Department of Economics, Reference Centre, Social Science Centre, University of Western Ontario, London, Ontario, Canada N6A 5C2

Phone: 519-661-2111 Ext.85244
Web page: http://economics.uwo.ca/research/research_papers/department_working_papers.html

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  1. Cogan, John F, 1981. "Fixed Costs and Labor Supply," Econometrica, Econometric Society, vol. 49(4), pages 945-63, June.
  2. Ian Walker & Ian Preston, 1999. "Welfare measurement in labour supply models with nonlinear budget constraints," Journal of Population Economics, Springer;European Society for Population Economics, vol. 12(3), pages 343-361.
  3. Hansen, Gary D., 1985. "Indivisible labor and the business cycle," Journal of Monetary Economics, Elsevier, vol. 16(3), pages 309-327, November.
  4. Shoven,John B. & Whalley,John, 1992. "Applying General Equilibrium," Cambridge Books, Cambridge University Press, number 9780521319867, Junio.
  5. 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.
  6. 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.
  7. Shulamit Kahn & Kevin Lang, 1988. "The Effects of Hours Constraints on Labor Supply Estimates," NBER Working Papers 2647, National Bureau of Economic Research, Inc.
  8. William T. Dickens & Shelly J. Lundberg, 1985. "Hours Restrictions and Labor Supply," NBER Working Papers 1638, National Bureau of Economic Research, Inc.
  9. Blundell, Richard & Macurdy, Thomas, 1999. "Labor supply: A review of alternative approaches," Handbook of Labor Economics, in: O. Ashenfelter & D. Card (ed.), Handbook of Labor Economics, edition 1, volume 3, chapter 27, pages 1559-1695 Elsevier.
  10. 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.
  11. 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.
  12. Richard Blundell, 1992. "Labour supply and taxation: a survey," Fiscal Studies, Institute for Fiscal Studies, vol. 13(3), pages 15-40, January.
  13. 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.
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