Effect of Personal Income Taxes on Labor Supply

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Presentation transcript:

Effect of Personal Income Taxes on Labor Supply Anderson: Incentive Effects of Taxation

Introduction The existence of taxes brings with it incentives to change behavior. In this chapter we examine how taxes provide incentives to change behavior in three specific ways: Labor supply Savings Tax evasion Copyright © by Houghton Mifflin Company. All rights reserved.

Five Principles Raising Adequate Revenue Neutrality Fairness Ease of Administration and Compliance Accountability

Taxation and Labor Supply Labor-leisure choice problem. People value both income and leisure. In order to earn income, one must work. The problem is to allocate time, a scarce resource, to labor and leisure. Copyright © by Houghton Mifflin Company. All rights reserved.

Labor-Leisure Choice Time endowment T. Allocate time to leisure activity l or work activity T - l. Work pays wage of w per hour. Wage income is y = w x (T - l). Optimal combination of labor and leisure is that where the MRS between income and leisure equals the wage. Copyright © by Houghton Mifflin Company. All rights reserved.

Figure 11.1: Labor/Leisure Choice Copyright © by Houghton Mifflin Company. All rights reserved.

Figure 11.2: Labor Supply Effects of a Wage Reduction Copyright © by Houghton Mifflin Company. All rights reserved.

Copyright © by Houghton Mifflin Company. All rights reserved.

Figure 11.3: Substitution and Income Effects of a Wage Reduction Copyright © by Houghton Mifflin Company. All rights reserved.

Figure 11.4: Effects of a Wage Reduction When the Income Effect Dominates Copyright © by Houghton Mifflin Company. All rights reserved.

Figure 11.5: The Laffer Curve Copyright © by Houghton Mifflin Company. All rights reserved.

Copyright © by Houghton Mifflin Company. All rights reserved.

Copyright © by Houghton Mifflin Company. All rights reserved.