• Is it always the case that the person will reduce hours of work when a tax is imposed (or increased)?
• No. Figure 16.3 shows a case where hours of work increases from FT to JT (and the person is still worse off relative to no taxes).
– Income effect – The person feels poorer after the effective wage cut and, if leisure is a normal good, the person consumes less of it (↓ leisure).
11
– The person is worse off after the tax, that is, utility is lower
– In this case, the person reduces hours of work from FT to IT.
8
Labor Supply: Theoretical Considerations
– Time Endowment (T) – Budget constraint, with a price of leisure of
$w – Preferences
3
Labor Supply: Theoretical Considerations
• Figure 16.1 shows a typical labor supply framework.
• Budget constraint rotates from TD to TH.
6
Figure 16.2
Labor Supply: Theoretical Considerations
• Based on the specific indifference curves in Figure 16.2, we can conclude the following:
Chapter 16 – Personal Taxation and Behavior
Public Finance
1
Aaron S. Yelowitz - Copyright 2003 © McGraw-Hill
Introduction
• A key policy question is how do households respond to the incentives presented in the U.S. tax code?
• We will examine:
– Labor supply – Saving – Housing – Portfolio Composition
2
Labor Supply: Theoretical Considerations
• Recall, from previous discussions of the welfare system, that a labor supply problem has the following elements:
• The effective wage rate (and the slope of the budget constraint) changes as hours of work increase.
12
Labor Supply: Theoretical Considerations
• Figure 16.4 depicts this situation. • Budget constraint is now TLMN. • In this figure, person maximizes utility at E4. • One common theoretical prediction that arises
9
ห้องสมุดไป่ตู้
Figure 16.3
Labor Supply: Theoretical Considerations
• Increasing (or decreasing) taxes changes the after-tax wage rate. Changing the wage rate has two effects:
• In Figure 16.2, tax reduces wage rate
– From $w to $(1-t)w, because person only cares about part of wage he gets to keep
– Tax reduces the opportunity cost of another hour of leisure
– Substitution effect – leisure is relatively less costly after the effective wage is cut, so a person substitutes toward leisure and away from work (↑ leisure).
Labor Supply: Theoretical Considerations
• Progressive taxes
– Consider three tax rates – t1 for income under L – t2 for income between L and M – t3 for income greater than M
• Person chooses FT of work in this example and attains utility on indifference curve ii.
4
Figure 16.1
Labor Supply: Theoretical Considerations
• How do taxes affect the work decision?