Labor-Leisure Choice and Relative Income Concerns in the Shadow of the Housing Market

We theoretically examine the connection among labor productivity, work time, and housing costs in an economy with households differing in wages and neighborhoods differing in quality. We argue that the location rent component of housing cost is key to explicating the connection. We trace how the housing market makes relative income instrumental for maximizing utility even if households’ utility functions are not interdependent. Over time, productivity growth yields higher wages but households compete some of that away on the housing market. This structural inflation of location rents counteracts preferences to work less as wages rise and hinders the expansion of leisure. Relative income effects are shown to arise as a consequence of a market institution that monetizes socially-imbued preferences.     

Uncertainty, Commitment, and Optimal Taxation

This paper examines the optimal tax design problem in the presence of wage uncertainty. The wage has a continuous distribution, individuals are ex ante identical, preferences are separable in labor supply and goods, public policy aims at providing the population with social insurance, and the only restriction on the tax instruments is that emanating from lack of public observability of realized wages and labor supplies. We show that optimal tax structures depend crucially on whether it is labor supply or goods that consumers have to commit to before the resolution of uncertainty. Specifically, we prove that, in the absence of commitment, the social insurance problem collapses to the traditional optimal tax problem. Second, if labor supply is precommitted, it would be possible to effect a first-best outcome. Third, commitment to goods would make indirect taxation a useful instrument of tax policy even in the presence of a general income tax; it requires differential tax treatment of committed and noncommitted goods. Finally, if preferences are separable between the two types of goods, precommitted goods must be taxed at a uniform rate lower than that on the noncommitted goods.     

Consumption externalities, production externalities, and efficient capital accumulation under time non-separable preferences

The effects of consumption and production externalities on economic performance under time non-separable preferences are examined both theoretically and numerically. We show that a consumption externality alone has long-run distortionary effects if and only if labor is supplied elastically. With fixed labor supply, it has only transitional distortionary effects. Production externalities always generate long-run distortions, irrespective of labor supply. The optimal tax structure to correct for the distortions is characterized. We compare the implications of this model with those obtained when the consumption externality is contemporaneous. While some of the long-run effects are robust, there are also important qualitative and quantitative differences, particularly along transitional paths.     

Indeterminacy in dynamic models: When Diamond meets Ramsey

We consider an aggregate two-periods overlapping generations model with endogenous labor, consumption in both periods of life, homothetic preferences and productive external effects coming from the average capital and labor. We show that under realistic calibrations of the parameters, in particular a large enough share of first period consumption over the wage income, local indeterminacy of equilibria cannot occur with capital externalities alone. It can nevertheless occur when there are only, even very small, vanishing labor externalities provided that the elasticity of capital-labor substitution and the wage elasticity of the labor supply are large enough. We also show that if labor externalities are slightly stronger, but still small enough to be plausible, and the elasticity of labor supply is larger, local indeterminacy occurs in a Cobb-Douglas economy. Finally, we show that a locally indeterminate steady state is generically characterized by an under-accumulation of capital. It follows therefore that while agents live over a finite number of periods, the conditions for the existence of locally indeterminate equilibria are very similar to those obtained within infinite horizon models and that from this point of view, Diamond meets Ramsey.     

Aggregate labor market fluctuations under news shocks

The standard RBC model fails to replicate the relationship between aggregate hours worked and average productivity. We propose a DSGE model that incorporates habit formation preferences, capital adjustment costs, and news shocks to solve the puzzle implied in the standard RBC model with only technological shocks. The aggregate labor supply curve is shifted due to the wealth effect caused by the variation of consumption under a news shock. Moreover, capital adjustment costs help amplify the variation of consumption, and thus the movement of the aggregate labor supply curve under the news shock. Also, the aggregate demand curve will be shifted, as it operates in the standard RBC model after the realization of the news shock. As a result of the joint movement of the aggregate labor supply curve and aggregate labor demand curve under the news shock, the model achieves a relationship quite close to the empirically observed relationship.     

WHY DO EUROPEANS WORK SO LITTLE?*

Market work per person is roughly 10% higher in the United States than in Sweden. However, if we include the work carried out in home production, the total amount of work only differs by 1%. I set up a model and show that differences in policy—mainly taxes—can account for the discrepancy in both labor supply and home production between Sweden and the United States. These results are independent of the elasticity of labor supply.     

Epstein–Zin Utility,Asset Prices,and the Business Cycle Revisited

This paper discusses the advantages of Epstein and Zin (1989) (EZ) preferences when building dynamic stochastic general equilibrium (DSGE) models that are consistent with well‐known stylized facts of both the business cycle and asset markets. To this end, we combine EZ preferences with several building blocks from the DSGE literature that has tried to solve the equity premium puzzle and to replicate characteristic statistics of the labor market. Our goal is to guide researchers in this area to useful modeling devices and to discuss EZ preferences vis‐a‐vis the standard time‐additive expected utility function. EZ preferences separate the attitude toward risk from the attitude toward intertemporal substitution. We demonstrate that this additional degree of freedom allows us to closely match the empirical facts already in a frictionless production economy with endogenous labor supply. Our study follows Heer and Maußner (2013). We examine models that consider adjustment costs of capital accumulation, consumption habits, and frictions in the allocation of labor. Our empirical targets are estimated from German data.     

Labor supply, home production, and welfare comparisons

We consider the collective model of labor supply with marketable domestic production. We first show that, if domestic production is mistakenly ignored, the ‘collective’ indirect utility functions that are retrieved from observed behavior will be unbiased if and only if the retrieved from observed behavior will be unbiased if and only if the profit function is additive. Otherwise, in the non-additive case, the direction and the size of the bias will depend on the complementarity-substitutability of spouses' time inputs in the production process. We then show that, even if domestic labor supply functions are not observed, valid welfare comparisons are possible. This identification result generalizes that in Chiappori [Chiappori, P.A., 1992. Collective labor supply and welfare. Journal of Political Economy 100, 437-467].     

Adjustment Costs, Firm Responses, and Micro vs. Macro Labor Supply Elasticities: Evidence from Danish Tax Records

We show that the effects of taxes on labor supply are shaped by interactions between adjustment costs for workers and hours constraints set by firms. We develop a model in which firms post job offers characterized by an hours requirement and workers pay search costs to find jobs. We present evidence supporting three predictions of this model by analyzing bunching at kinks using Danish tax records. First, larger kinks generate larger taxable income elasticities. Second, kinks that apply to a larger group of workers generate larger elasticities. Third, the distribution of job offers is tailored to match workers' aggregate tax preferences in equilibrium. Our results suggest that macro elasticities may be substantially larger than the estimates obtained using standard microeconometric methods.     

Revenue Recycling and the Welfare Effects of Road Pricing

This paper explores the interactions between taxes on work-related traffic congestion and pre-existing distortionary taxes in the labor market. A congestion tax raises the overall costs of commuting to work and discourages labor force participation. The resulting welfare loss in the labor market can easily exceed the Pigouvian welfare gain from internalizing the congestion externality. However, if congestion tax revenues are used to reduce labor taxes, the net impact on labor supply is positive, and this can raise the overall welfare gain from the congestion tax by around 100 percent. Nonetheless the optimal congestion tax still equals the Pigouvian tax.
JEL classification R 41; H 21; H 23     

Optimal Income Taxation with Endogenous Human Capital

This paper augments the theory of optimal linear income taxation by taking into account human capital accumulation as a dimension of labor supply. The distribution of earning potentials is endogenous because agents differ in the ability to learn. Taxation affects utilization rates of human capital through labor supply responses. The costs of education that are not deductible from the income tax distort the learning decision as well. We show theoretically that the trade‐off between efficiency and equity is worsened. Quantitative analysis shows that the distortionary costs of taxation increase substantially when human capital formation is endogenous.     

Consumption externalities,production externalities,and long-run macroeconomic efficiency

We analyze the effects of consumption and production externalities on capital accumulation. We show that the importance of consumption externalities depends upon the elasticity of labor supply. If the labor supply is inelastic, consumption externalities cause no long-run distortions. Whether there are distortions along the transitional path depends upon consumer preferences. The effects of production externalities are more pervasive; they exert long-run distortionary effects irrespective of labor supply. The optimal taxation to correct for the distortions created by the externalities is characterized. We analyze both stationary and endogenously growing economies, and while there are many parallels in how externalities impact, there are also important differences.     

Relative Affluence and Child Labor—Explaining a Paradox

Some micro level empirical studies found child labor incidence increasing even with improvement in the economic conditions of the poor. This paper provides a possible explanation as to why increase in absolute income may not be sufficient to solve the problem of child labor. We argue that people in general are not just concerned about their own consumption; they are very much affected by the consumption of their peers. While taking decisions regarding the time allocation of their children between work and leisure, parents do keep an eye on their relative position in the society. We develop a theoretical model of household decision making to show that child labor supply from a poor family can increase even with improvements in its economic conditions, if the family's relative position in the society deteriorates and if the relative status effect is sufficiently strong.     

The equity premium in a small open economy and an application to Israel

We show that the preferences suggested by Greenwood, Hercowitz and Huffman (GHH), which are quite common in real business cycle (RBC) models of small open economies, are not suited for reproducing both the business cycle and the equity premium facts of a small open economy. We show that by assuming a moderate degree of a wealth effect on labor supply, together with some limitations on labor supply (in the form of real wage rigidity), we can increase the volatility of the stochastic discount factor (SDF), thereby increasing the equity premium and improving the fit of the business cycle moments. We also find that under the aforementioned assumptions, a shock to the realized return on foreign bonds can help in reproducing the equity premium.     

Convergence in a Dynamic Heckscher–Ohlin Model with Land

Convergence among nations that share the same preferences and technologies is a key result of the closed‐economy neoclassical growth framework that has received substantial support in the data. However, Heckscher–Ohlin versions of the two‐sector neoclassical growth model predict that nations that differ in their capital–labor ratios may not converge to the same steady state, even if they are identical in all other aspects. This is a puzzling result that warns us about potential dangers of international trade. In this paper we show that when land, an input in fixed supply, is introduced into the model, international trade in goods no longer limits the capacity of poor nations to catch up with the advanced world.     

Optimal climate and fiscal policy in an OLG economy

This paper develops a climate–economy model to study the joint design of optimal climate and fiscal policies in economies with overlapping generations (OLGs). I demonstrate how capital taxation, if optimal, drives a wedge between the market costs of carbon (the net present value of marginal damages using the market interest rate) and the Pigouvian tax (the net present value of marginal damages using the consumption discount rate of successive OLGs). In contrast to deterministic infinitely lived representative agent models, at the optimum, the capital income tax is positive, the carbon price equals the market costs of carbon but it falls short of the Pigouvian tax when (i) preferences are not separable over consumption and leisure; and (ii) labor income taxes cannot be age-dependent. I also show that restrictions on climate change policy provide a novel rationale for positive capital income taxes.     

A Distortive Wage Tax and a Countervailing Commuting Subsidy

Within a second-best duocentric urban economics framework where labor income taxation distorts workplace choices on account of commuting costs, this paper studies a commuting subsidy, which distorts land use. It is shown that a commuting subsidy increases welfare if and only if it shifts labor supply from less to more productive business districts.     

Tuition Fees and the Dual Income Tax: The Optimality of the Nordic Income Tax System Reconsidered

Abstract. We examine the optimal tax and education policy in the case of a dual income tax. Incorporating an educational sector and endogenous capital taxation, we show that the results in Nielsen and Sørensen's study are vulnerable with respect to assumptions on the elasticity of unskilled labor supply. Tax progressivity results residually, whereas educational policy guarantees an optimal tax wedge on, but not necessarily efficiency in, educational investment. The less elastic are the unobservable educational investment and skilled labor (the latter relative to unskilled labor supply), and the more educational policy cares about the skilled labor supply, the more progressive the tax system will be. Education will be subsidized on a net basis if the complementarity effect on the skilled labor supply is strong and important; however, there is also an offsetting substitutability effect of the unskilled labor supply at play.     

Four Simple Tests of Campaign Contributions and Trade Policy Preferences

This paper uses campaign contribution data to examine trade policy preferences among political action committees. With perfect factor mobility, as the Heckscher–Ohlin (HO) model assumes, interest group trade positions should depend on their factor of production but not on their industry. We show, consistent with the 2 × 2 HO model, that capital groups consistently back representatives supporting trade liberalization while labor groups favor protectionists. Unlike previous work, we also measure the variation in trade policy preferences within capital and labor groups. We find evidence that the industry net export position significantly affects labor unions' trade policy preferences. Industry characteristics have no impact on capital group lobbying. The former result suggests that empirical analyses of labor PAC contributions that exclude industry characteristics may be misspecified.     

The quest for status and endogenous labor supply: the relative wealth framework

We analyze the implications of relative wealth preferences in a Ramsey model with endogenous labor supply. In contrast to relative consumption preferences, they allow for the possibility that agents work too little in the long run, while under both specifications the steady-state levels of consumption and the stock of physical capital exceed their socially optimal counterparts. Even in the case of excessive leisure agents are worse off in terms of intertemporal utility because initial transitional dynamics are characterized by under-consumption and excessive work effort. “Too much” long-run consumption of goods and leisure is possible due to the excessive capital-labor ratio.