Working Paper: CEPR ID: DP6265
Authors: Alison L. Booth; Melvyn G. Coles
Abstract: This paper considers optimal educational investment and labour supply with increasing returns to scale in the earnings function In so doing we develop the work of Rosen (1983), who first highlighted the increasing returns argument that arises because private returns to human capital investment are increasing in subsequent utilization rates. We demonstrate that increasing returns generates task specialisation - individuals choose to become either home specialists or work specialists. With heterogeneous workers, we show for certain types, that a tax on labour income leads to large, non-marginal substitution effects; i.e. those with a comparative advantage in home production are driven out of the market sector. Tax deadweight losses are consequently large. Consistent with the theory, our empirical results, using a cross-country panel, find that gender differences in labour supply responses to tax policy can play an important role in explaining differences in aggregate labor supply across countries.
Keywords: Fiscal Policy; Household Production; Increasing Returns; Labour Supply
JEL Codes: H24; J13; J24; J31
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Tax on labor income (H31) | Labor supply (J22) |
| Tax on labor income (H31) | Educational investments (I26) |
| Higher tax rates (H29) | Labor market participation rates (J49) |
| Higher tax rates (H29) | Female labor market participation (J21) |
| Public childcare provisions (J13) | Female labor market participation (J21) |
| Tax policy (H29) | Aggregate labor supply variations (J22) |
| Gender differences in labor supply responses (J22) | Aggregate labor supply variations (J22) |
| Higher tax rates (H29) | Deadweight losses (H21) |
| Increasing returns to scale in earnings function (I26) | Specialization in home or market production (D13) |
| High labor supply in Scandinavian countries (J29) | Favorable treatment of second earners and public childcare benefits (J13) |