Working Paper: NBER ID: w10138
Authors: Edgar Cudmore; John Whalley
Abstract: This paper sets out alternatives to the traditional model of labour supply used to analyse the welfare costs of income and/or sales taxes when preferences are defined over goods and leisure and the market wage yields the slope of the budget constraint. The innovation in our work is to assume that some or all of non market time is used to regenerate the productivity of labour through rest and relaxation. This model has no closed form solution, but we can work with the first order conditions numerically for specific functional forms using non linear solution software. We generate a number of alternative parameterizations of this model through a series of calibrations to the same synthetic base case data set. Across the resulting parameterizations the welfare costs of taxes vary substantially (by a factor of twenty fold in some counterfactual analyses), even though they all involve calibration to the same base case data and labour supply elasticity. These results thus suggest that a small and seemingly plausible departure from a standard model (even if not in closed form) that has dominated the economic literature for many years can yield substantial change for perspectives on policy interventions.
Keywords: No keywords provided
JEL Codes: J2; H2; D1; D6
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| non-market time (regeneration) (R33) | labor efficiency (J89) |
| non-market time (regeneration) (R33) | welfare costs associated with labor income and sales taxes (J32) |
| traditional model of labor supply (J29) | underestimation of welfare costs associated with taxes (H21) |
| non-market time used for regeneration (Q21) | labor income taxes appear neutral (H31) |
| deviation from traditional model (C52) | significant changes in welfare cost estimates (D69) |
| traditional models (C20) | distort labor supply decisions (H31) |
| observationally equivalent parameterizations (C30) | range of welfare cost estimates (D69) |