4. Budget Deficits & Taxation: Taxes&Incentives Labour Taxes

Question 1

What 2 papers are relevant for looking at the implications of labour taxation for deficits and incentives?

Answer 1

Prescott (2004) “Why do Americans work so much more than Europeans”

Guvenen, Kuruscu, Ozkan (2012) “Taxation of human capital and wage inequality: A cross-country analysis”

Question 2

Give the equation for the agents problem in Prescott (2004)

What is the budget constraint?

Answer 2

max┬(c,l) log⁡(c)+αlog⁡(1-l)

c=(1-τ)wl+H/(1+τ_c )

where τ = (1- τl)/(1+ τc)

Question 3

What are the key findings of Prescott (2004)?

Answer 3

The reason that Europeans work fewer hours is that they are subject to much higher taxes, which discourages them from working

The US has lower tax rates, so labour supply there is higher

Question 4

What problems are there with Prescott (2004)?

(large point)

What can be concluded from this issue?

Answer 4

Only measures the difference in hours for an average of all workers in countries - doesn’t consider participation of different parts of the labour force
There is a big difference in participation rates for young people, women and children between countries

Focus should be placed on other government programs too (education, disability, retirement etc.)

Question 5

What is studied in Guvenen, Kuruscu & Ozkan (2014)?

What are the findings? (elaborate)

Answer 5

Progressivity of taxation

Find a negative relationship between tax progressivity and inequality (i.e. high progressivity is associated with low inequality, as the wage schedule is compressed due to the redistribution of wages from rich to poor)

Question 6

What are the 2 channels through which taxation affects labour supply?

Answer 6

Intertemporal (ct/yt)

Intratemporal (α/(1-τt ))

Question 7

What is the firms optimality condition (where wage = MPL) rearranged to give a formula for labour supply?

Answer 7

ht=(1-θ)/[1-θ+(ct/yt )(α/(1-τt ))]

Question 8

How does the intertemporal channel affect labour supply?

2 points

Answer 8

If people believe that future taxes will be higher then they will save more today

I.e. consumption falls if expected future taxes are increased

Question 9

How does the intratemporal channel affect labour supply?

Answer 9

If current taxes fall then labour supply will increase in the current period