Progressive Taxation and the Life-Cycle Model: An Application of the Theory of Firm*

In the presence of a progressive consumption (wage income) lax the marginal cost of consumption (leisure) is rising and* the life-cycle allocation problem of an individual is presentable in the framework of a monopsony. Although the progressive taxes do not in general alter the qualitative nature of standard results on life-cycle theory, their quantitative implications are serious. In contrast to the equivalence between proportional consumption and wage income taxes, the effects of the two progressive taxes on the life-cycle consumption and labour supply allocation decision are not only different but in most cases also in opposite directions.     

Hours risk and wage risk: repercussions over the life cycle*

We decompose earnings risk into contributions from hours and wage shocks. To distinguish between hours shocks, modeled as innovations to the marginal disutility of work, and labor supply reactions to wage shocks, we formulate a life-cycle model of consumption and labor supply. For estimation, we use data on married American men from the Panel Study of Income Dynamics. Permanent wage shocks explain 31 percent of total risk, permanent hours shocks 21 percent. Progressive taxation attenuates cross-sectional earnings risk, but its life-cycle insurance impact is much smaller. At the mean, a one-standard-deviation hours shock raises lifetime income by 11 percent, a wage shock by 13 percent.     

Optimal nonlinear income taxation with learning-by-doing

This paper examines a two-period model of optimal nonlinear income taxation with learning-by-doing, in which second-period wages are an increasing function of first-period labour supply. We consider the cases when the government can and cannot commit to its second-period tax policy. In both cases, the canonical Mirrlees/Stiglitz results regarding optimal marginal tax rates generally no longer apply. In particular, if the government cannot commit and each consumer's skill-type is revealed, it is optimal to distort the high-skill type's labour supply downwards through a positive marginal tax rate to relax an incentive-compatibility constraint. Our analysis therefore identifies a setting in which a positive marginal tax rate on the highest-skill individual can be justified, despite its depressing effect on both labour supply and wages.     

Tax reform in a two-class growth model

This paper analyzes the welfare and distributional effects of tax reforms in a two-class model with exogenous labour supply. It extends the empirically calibrated, standard life-cycle model to include both pure life-cycle savers and households with an altruistic bequest motive. The tax reform simulations cover the move from an income to a wage and a consumption tax, respectively. The role of borrowing constraints is studied and a dynamic analysis of tax reforms using a static expectation approach is performed. The simulation results indicate that the two tax reforms have different impacts on the welfare of the two classes: while the pure life-cycle savers are better off with the consumption tax, the altruistically motivated households gain more under a wage tax. The results further show that while the introduction of a consumption tax is distributionally neutral, the move to a wage tax substantially increases income and wealth inequality.     

The choice of excise taxes when savings and labour decisions are distorted

The framework is a simple two period life-cycle model with identical individuals who work in period 1 and are retired in period 2. Initially there are optimally chosen uniform income and commodity tax rates, which lead to distortions in both the labour/leisure choice and the consumption/savings choice. The purpose is to demonstrate in an intuitively comprehensible way how differentiating commodity taxation by slightly increasing the tax on one consumption good can mitigate existing distortions. The sufficient conditions for a welfare improvement are similar to that of Corlett and Hague plus some conditions on average and marginal consumption propensities.     

A DISEQUILIBRIUM MODEL UNDER BILATERAL MONOPOLY*

The paper points out a crucial difference between the conventional disequilibrium macro model and partial equilibrium models of wage bargaining, In the former the real wage is constrained to be less than or equal to the marginal product, whereas in the latter the real wage is frequently constrained to be greater than or equal to the marginal product. The paper builds a disequilibrium model under bilateral monopoly, paying explicit attention to the labour market. The well-known union model of McDonald and Solow forms the basis of the labour market analysis. Just as the three regions of Keynesian Unemployment, Classical Unemployment and Repressed Inflation are configured in the conventional case, an equivalent exercise is undertaken but with the addition of a collectively negotiated wage. The particular wage agreement used is the Nash bargain. The framework is then used to account for the unusual events that occurred in the UK labour market 1979–81, particularly the unprecedented rise in unemployment with no diminution of the inflation rate. It suggests that there was a shift in bargaining advantage in favour of employers, which resulted in an increased share of profits in national income. This regime change exacerbated the unfavourable circumstances for labour, which existed at that time.     

On the switch from direct to indirect taxation

The paper is concerned with the inter-relationship between the theoretical specification of household behaviour and the application of econometric results to the analysis of public policy. The first part of the paper discusses the relationship between the optimum tax literature and econometric specification of point labour supply and commodity demands. The second part introduces an ‘activity model’ of the allocation of money and time, which generalises the standard linear expenditure system, and describes the preliminary results of estimating the model for the United Kingdom Family Expenditure Survey data for 1973. The remainder of the paper uses the estimates to examine the effect of reducing income taxation and increasing value added tax on both labour supply and welfare.     

Reconsidering the Marginal Welfare Cost of Taxation*

A model with sticky wage rates and involuntary unemployment is used to compute the marginal cost of taxation, and these estimates are compared with those obtained from the conventional price-clearing equilibrium model. Important determinants of the marginal cost estimates are the response of sticky wages to a tax increase, the elasticity of demand for labour, and the unemployment gap. By contrast, the conventional model focuses on the elasticity of labour supply. The different models have different implications for efficient tax design. However, the new model generally agrees with the conventional model regarding significant efficiency costs of higher taxation.     

Marginal Tax Rate Uncertainty and Wage Indexation

Frequent changes in American tax laws over the last 30 years have led to uncertainty regarding the marginal tax rate on labour income. Using a multisector framework, this paper considers the implications of the tax rate uncertainty for wage flexibility. The Fiscal Authority sets the marginal wage tax rate, and is assumed to be the leader in a Stackelberg game. Wage setters in this game determine the degree of optimal indexation and are assumed to be followers. Increases in tax rate uncertainty lead to greater nominal wage flexibility, and a decrease in optimal progressivity. Additionally, indexation to nominal shocks is complete even if the product market is monopolistically competitive.     

The impact of taxes on female labour supply

There is little agreement in economics on the factors influencing labour supply and hence on the impact of taxes. Within the marginal model, real wages and incomes are directing people's labour market behaviour independent of time and space, whereas the human resources approach takes account of the social environment and past behaviour. Even if strong assumptions are made, the neoclassical theory cannot predict the outcome of a wage increase. The labour supply response depends on the relative strengths of the substitution and the income effect. Since nonparticipation in the labour market is explained by a reservation wage being higher than the market wage, this is the only situation in which neoclassical theory would predict a rise in labour force participation with a wage increase. This case occured in a ‘natural experiment’ in Sweden. The Swedish tax system changed in 1971 from joint to separate taxation of spouses resulting in a substantial increase in the net wage of married women. This article investigates the impact of the change in the Swedish tax system on female labour force participation, concluding that it cannot explain the substantial rise in the participation rates of Swedish women. This is a significant result, questioning standard neoclassical theory and supporting the more institutional views of human labour market behaviour. That is that time and space as well as the social environment are important when analyzing labour supply. This will have consequences for international comparisons. Only factors which explain developments within one country might be relevant for explaining international differences, e.g. in labour force participation.     

Analysis of the 1980 Sydney Survey of Work Patterns of Married Women: Further Results*

Using cross-section data from the 1980 Sydney survey of the work patterns of married women, this paper contributes to the very scarce Australian stock of disaggregate econometric studies of the labour market activities of married women. Labour force participation, hours of work and wage functions (reservation wage as well as market wage) are estimated in a second-generation static labour supply framework. Unique features of the study include the availability of direct data on previous market experience, a formulation of the impact of children on the participation decision which permits testing for the presence of economies of scale in child-minding activities, estimation of the reservation wage function, and a data base which permits a clear distinction between earnings and other forms of income.     

Model design and simulation

The purpose of this paper is to illustrate some of the uses of simulation in building econometric models. By its means we can solve complicated non-linear systems and discover how sensitive the solutions are to changes in the parameter values and in the form of particular relationships. These uses are exemplified in a simple model of cyclical growth, whose stability depends on the speed with which the wage rate is kept adjusted to the marginal product of labour.     

Dynamic factor models of consumption,hours and income

This paper addresses two questions in the economics of intertemporal choice. First, what are the key factors that drive fluctuations in income and what are the time paths of their effects? Second, how do consumers respond to these factors? We answer these questions by estimating dynamic factor models of consumption, hours, wages, unemployment, and income that account for measurement error and the fact that variables used in the study are measured at different time intervals and/or are aggregates for the calendar year. We pay special attention to a dynamic factor representation of a joint life cycle model of consumption and labour supply, which permits us to quantify the effect of wages, unemployment, and other factors on the marginal utility of income as well as to estimate the substitution effects of wage changes on labour supply and consumption.     

Skilled–unskilled wage inequality,nontraded good and endogenous supply of skilled labour: A theoretical analysis

The paper develops a static four sector competitive general equilibrium model of a small open economy in which skilled labour is endogenously produced by the education sector and is mobile between a traded good sector and a nontraded good sector. Capital is also perfectly mobile among the education sector, skilled labour using traded good sector and the nontraded good sector. However, land and unskilled labour are specific to another traded good sector. We analyse the effects of change in different factor endowments and reduction in tariff rate on skilled–unskilled wage inequality. We find that the effect of a change in different parameters on wage inequality depends on the factor intensity ranking between two skilled labour using sectors and on the relative strength of the marginal effects on demand for and supply of nontraded final good. We also analyse the effects of changes in different parameters on the supply of skilled labour.     

TAXATION AND CENTRALISED WAGE SETTING: THE CASE OF ENDOGENOUS LABOUR SUPPLY

The implications of centralised wage setting for the relationship between taxation, wages and employment are studied allowing for endogenous adjustment in work hours. We show that centralisation promotes wage moderation, makes wages and employment less sensitive to changes in wage taxation and reduces the hours worked. With an individual supply of working hours, a wage tax can even improve employment if wage setting is centralised and marginal utility from a public good is sufficiently high. Moreover, if a profit tax is used to finance public expenditure, higher tax reduces wages and improves employment.     

The determinants of female labour supply in Hungary

The aim of this paper is to closely examine the effect on a married woman's labour supply decision of non-labour income and of her own wage rate in a transition economy. The paper first shows that labour force participation rates for Hungarian females, though decreasing, were still extremely high and comparable to male economic activity in western countries. It then estimates labour supply parameters using a model that controls for sample selection issues associated with the labour supply of married women. Wage elasticity is estimated to be high and positive (1.81) while the income effect is consistent with leisure being a normal good. No sample selection bias is found.     

Asymptotic Marginal Tax Rate of Individual Income Tax in China

This paper examines the asymptotic marginal rate of individual income tax which maximizes China's social welfare through numerical simulation based on the elasticity of China's labor supply, income distribution and the social objectives of redistribution in accordance with the optimal direct taxation theory. Taking advantage of the optimal direct taxation model with consideration of the income effect, it comes to the conclusion that combined with China's reality, the asymptotic marginal rate of individual labor income tax in China should be between 35% and 40%.     

The Cost of Public Funds in Australia*

A model of labour supply is used to calculate Australia's marginal cost of public funds, which is the appropriate cut-off benefit/ cost ratio for an additional public project. The labour supply model incorporates effective average and marginal tax rates faced by the representative household in each gross income decile. These rates are estimated from the ABS 1988–89 Household Expenditure Survey. A simulation analysis is performed to calculate the effect on labour supply of a 1 per cent increase in marginal tax rates. The estimated changes in tax revenues and deadweight loss in each decile are used to estimate the marginal cost of public funds.     

The distribution of abilities and the progressive income tax

This paper develops a model of endogenous labor supply, where agents are uncertain about their future wages. Assuming risk aversion, some redistributive taxation is thus warranted. It is shown that, for a particular parameterization of the tax system, an optimally progressive income tax exists. Comparative ststics analysis demonstrates how this tax system is effected by changes in the wage distribution. The paper ends with a discussion of whether an optimally progressive income tax can be politically sustained. It is shown that generally this is not the case in a political system with majority voting.