1. PERSONAL TAXATION AND BEHAVIOR
Chapter 18

2. Labor Supply D Income per week |Slope| = w E1 G iii ii Income i
Leisure
Work
Hours of leisure per week F T
time endowment

3. Effects of Taxation D Income per week |Slope| = w H E1 G iii ii
|Slope| = (1-t)w
Hours of work after tax E2 G’ i F I T
Hours of leisure per week
Hours of work before tax

4. Effects of Taxation D Income per week H E1 G iii E3
Hours of work after tax K ii i J F T
Hours of leisure per week
Hours of work before tax

5. Effects of Taxation D Income per week |Slope| = w |Slope| = (1-t2)w E1
(1-t1)$5,000 + (1-t2$5,000
(1-t1)$5,000
|Slope| = (1-t2)w
|Slope| = (1-t1)w P F T
Hours of leisure per week
Hours of work before tax

6. Empirical Findings Eissa [2001]
For males aged 20-60, the effect of changes in the net wage on hours worked is small and often statistically insignificant
Elasticity of approximately 0.05
For married females, the hours of work and labor force participation decisions are quite sensitive to changes in the net wage, although it has gotten smaller over time.
Elasticity of approximately 0.40

7. Some Caveats Demand-side considerations
Individual versus group effects
Other dimensions of labor supply: Human Capital
The compensation package
The expenditure side

8. Taxes and Human Capital Accumulation
Investing in human capital
B – C > 0
(1 – t)B – (1 – t)C = (1 – t)(B – C>) 0
Income versus substitution effects
Shortcomings of model
Returns uncertain
Explicit costs
Other taxes
Progressive taxes

9. Labor Supply and Tax Revenues
Wage rate per hour SL j a k c w b
(1-t1)w d e
(1-t2)w f
(1-tA)w i h
(1-t3)w L3 LA L2 L1 L0
Hours per week

10. Tax Rates versus Tax Revenue– Laffer Curve

11. Debate Over the Laffer Curve
The Laffer curve and the elasticity of labor supply
Where on the Laffer curve is the economy operating?
Other ways tax rates can affect tax revenues
Determining the optimal tax rate
Is maximizing tax revenue a valid goal?

12. Saving and the Life-Cycle Model
Future consumption c1
c1* E1
iii ii i I1
Endowment point
ІSlopeІ = 1 + r
Saving M
c0* I0
Present consumption (c0)

13. Deductible Interest Payments and Taxable Interest Receipts
Future consumption c1
c1* E1 P
c1t
After-tax budget line ІSlopeІ = 1 + (1-t)r I1 A
Saving after tax Q M
c0*
c0t I0
Present consumption (c0)
Saving before tax

14. Deductible Interest Payments and Taxable Interest Receipts
Future consumption c1
c1* E1 P
c1t
After-tax budget line ІSlopeІ = 1 + (1-t)r I1 A
Saving after tax Q M
c0t
c0* I0
Present consumption (c0)
Saving before tax

15. Nondeductible Interest Payments and Taxable Interest Receipts
Future consumption c1
c1* P
c1t
After-tax budget line ІSlopeІ = 1 + (1-t)r I1 A Q M I0
Present consumption (c0)

16. Some Additional Considerations
Real net rate of return
Many assets
Private saving versus social saving
Validity of life-cycle model
Empirical evidence: effect of taxation on saving
Problems using the regression approach
Specification issues
Measurement issues
Joint Committee on Taxation [2005]

17. Tax-Preferred Savings Accounts
Types of tax-preferred savings accounts and how they work
Are contributions to these accounts new saving?
Administrative details and effect on saving: insights from Behavioral Economics

18. Taxes and the Capital Shortage
Taxes and investment
Taxes and excess burden
Closed versus open economy

19. Housing Decisions Effects of the income tax on housing decisions
Rnet = R – I + ΔV
Implicit rent not taxed
Deductibility of mortgage interest and property tax payments
The decision to rent or buy

20. Proposals for Change Critique of subsidy for owner-occupied housing
Are there significant positive externalities?
Impact on distribution of income
Incentive to take on risky mortgages, contributing to the housing and financial crisis of
Political feasibility of taxing imputed rent
Reform proposals
Elimination of deduction for property tax and mortgage interest
Placing an upper-limit on deductions
Convert mortgage interest deduction into a credit

21. Portfolio Composition
Tobin’s model of portfolio composition
Impact of proportional tax with full loss offset
Impact on return
Impact on risk
Empirical evidence

22. A Note on Politics and Elasticities
Ambiguity about effect of taxation on behavior
Importance of elasticities
“Convenient” beliefs about elasticities

23. Chapter 18 Summary
The U.S. personal income tax affects several economic decisions including labor supply, housing consumption, saving, and human capital investment
Research into these affects are among the most contentious of all areas of public policies