Lecture8a.ppt

Lecture8a.ppt - Lecture8:TaxesandLabor Supply...

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    Lecture 8:  Taxes and Labor  Supply
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    Outline of lecture Taxes and hours of work: income vs. substitution effects Taxes and participation in labor market Empirical evidence on hours of work, labor force participation, and earnings Examination of effects of EITC program
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    Proportional tax and hours of work Budget line with taxes: where C is consumption, L is labor supply, T is total time available, w is wage rate, and t is tax rate (Note: For simplicity, ignoring any income from capital) T t w L T t w C ) 1 ( ) )( 1 ( - = - - +
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    Consumption Leisure BC 1 BC 2 slope = - w (1- t ) L 1 C 1
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    Income vs. Substitution Effects The tax clearly causes a shift to a lower indifference curve, lowering utility Decompose shift into two pieces: Income effect: Response to a lump-sum tax that would result in the same fall in utility as the actual tax change Substitution effect: Response to distortions in incentives, holding utility constant. The substitution effect captures the response to the price distortions per se
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    Consumption Leisure BC 1 BC 2 slope = - w C 1 Income effect Substitution effect Income vs. Substitution Effects
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    Substitution vs. Income Effects Income effect implies poorer, so buy less consumption goods and less leisure Substitution effect implies leisure cheaper, so buy more leisure Unclear in general whether leisure goes up or down due to the tax. Depends on which effect is larger.
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    Consumption Consumption Leisure Leisure BC 1 BC 2 BC 1 BC 2 L 1 L 1 L 2 L 2 C 1 C 2 C 1 C 2 Substitution effect is larger Income effect is larger
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    Excess burden Excess burden can be measured by the drop in utility, holding tax revenue fixed, from use of distorting taxes Excess burden then depends just on the substitution effect.
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    Consumption Leisure slope = - w C 1 Tax Revenue and Excess Burden
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  Implications of a  progressive tax schedule A progressive schedule provides an implicit lump sum transfer, T, for those in higher tax brackets. Due to these added income effects, labor
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This note was uploaded on 11/03/2009 for the course ACCT 130 taught by Professor Huxhold during the Spring '09 term at UCSD.

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Lecture8a.ppt - Lecture8:TaxesandLabor Supply...

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