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Taxes and Employment Subsidies in Optimal Redistribution Programs (Revised Version)

  • Beaudry, Paul

    (University of British Columbia, and NBER.)

  • Blackorby, Charles

    (University of Warwick and GREQAM)

  • Szalay, Dezso

    (University of Warwick)

This paper explores how to optimally set tax and transfers when taxation authorities : (1) are uninformed about individuals’ value of time in both market and non-market activities and (2) can observe both market-income and time allocated to market employment. We show that optimal redistribution in this environment involves distorting market employment upwards for low wage individuals through decreasing wage-contingent employment subsidies, and distorting employment downwards for high wage individuals through positive and increasing marginal income tax rates. In particular, we show that whether a person is taxed or subsidized depends primarily on his wage, that is, the optimal program involves a cut-off wage whereby workers above the cutoff are taxed as they increase their income, while workers earning a wage below the cutoff receive an income supplement (an earned income tax credit) as they increase their income. Finally, we show that the optimal program transfers zero income to individuals who choose not to work.

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Paper provided by University of Warwick, Department of Economics in its series The Warwick Economics Research Paper Series (TWERPS) with number 779.

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Length: 37 pages
Date of creation: 2006
Date of revision:
Handle: RePEc:wrk:warwec:779
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  1. Matthews, Steven & Moore, John, 1987. "Monopoly Provision of Quality and Warranties: An Exploration in the Theory of Multidimensional Screening," Econometrica, Econometric Society, vol. 55(2), pages 441-67, March.
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  5. Beaudry, Paul & Blackorby, Charles, 2004. "Taxes And Employment Subsidies In Optimal Redistribution Programs," The Warwick Economics Research Paper Series (TWERPS) 708, University of Warwick, Department of Economics.
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  18. Diamond, P., 1980. "Income taxation with fixed hours of work," Journal of Public Economics, Elsevier, vol. 13(1), pages 101-110, February.
  19. Philippe Choné & Guy Laroque, 2006. "Should Low Skilled Work be Subsidized ?," Working Papers 2006-08, Centre de Recherche en Economie et Statistique.
  20. David Card & Philip Robins, 1996. "Do Financial Incentives Encourage Welfare Recipients to Work? Early Findings from the Canadian Self Sufficiency Project," Working Papers 738, Princeton University, Department of Economics, Industrial Relations Section..
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