Journal Article

Employment, Hours of Work and the Optimal Taxation of Low-Income Families

Richard Blundell and Andrew Shephard

in The Review of Economic Studies

Published on behalf of Review of Economic Studies Ltd

Volume 79, issue 2, pages 481-510
Published in print April 2012 | ISSN: 0034-6527
Published online October 2011 | e-ISSN: 1467-937X | DOI: http://dx.doi.org/10.1093/restud/rdr034
Employment, Hours of Work and the Optimal Taxation of Low-Income Families

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  • Demand and Supply of Labour
  • Single Equation Models; Single Variables
  • Taxation, Subsidies, and Revenue

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The optimal design of low-income support is examined using a structural labour supply model. The approach incorporates unobserved heterogeneity, fixed costs of work, childcare costs and the detailed non-convexities of the tax and transfer system. The analysis considers purely Pareto improving reforms and also optimal design under social welfare functions with different degrees of inequality aversion. We explore the gains from tagging and also examine the case for the use of hours-contingent payments. Using the tax schedule for lone parents in the U.K. as our policy environment, the results point to a reformed non-linear tax schedule with tax credits only optimal for low earners. The results also suggest a welfare improving role for tagging according to child age and for hours-contingent payments, although the case for the latter is mitigated when hours cannot be monitored or recorded accurately by the tax authorities.

Keywords: Optimal taxation; Labour supply; Discrete choice; H21; J22; C25

Journal Article.  12887 words.  Illustrated.

Subjects: Demand and Supply of Labour ; Single Equation Models; Single Variables ; Taxation, Subsidies, and Revenue

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