Week 4

Question 1

What does a utilitarian welfare function imply?

Answer 1

It implies an optimal tax rate which equalizes the marginal utility per unit of revenue raised across individuals

MUi/MUr = lambda

Question 2

what two principles does the utilitarian method trade off?

Answer 2

Vertical equity - tax high incomes high (low marginal utility)
Behavioral response - more taxes in one group may lead to lower earning such that tax revenues will be smaller

Question 3

What did Eissa (1985) try to find in her study and how was it carried out?

Answer 3

Eissa tried to find out how earners respond to income tax changes by using the tax reform act of 1986 and a DiD to set it up.

Focused on married women (usually second earners) comparing the 99th percentile of high income earning women to the 70th percentile; the reason for picking these groups being that women with moderately high earnings saw much lower reductions in the marginal tax rate.

Women with very high earnings (relatively) increased their labor supply. A 10% increase in after-tax wages yields an 8% greater labor supply * elasticity of 0.8).

Question 4

What is the Earned income tax credit (EITC) scheme in the US?

Answer 4

It is the largest anti poverty program in the US and the idea is to provide tax refunds to low income households with children.

Question 5

Why do tax wedges matter?

Answer 5

if secondary earners repond strongly to changes in after-tax wages, they likely trade it off with childcare costs.

eg: the secondary earner can make 4000 euros but if they are taxed 50% and childcare is 2400 euros per month, we lose 1600, euros in productivity because they decide to stay at home. This is a tax wedge.

Question 6

How do we resolve tax wedges?

Answer 6

A tax wedge encourages people to undertake untaxed activities.

Solutions:

tax at home work; but problem being it has no market value
deductible child care costs: this reduces tax base, higher tax rates are needed to make up for this which will generate more welfare loss form taxation.

Question 7

What did Gelbach try to find in his study in 2002? What were the results he found?

Answer 7

Gelbach used quarter of birth (QOB) to identify kindergarten attendance. He used an instrumental variable approach.

First stage: regress kindergarten enrollment on QOB
Second stage: regress labor supply on predicted enrollment

He finds a positive effect of kindergarten enrollment on labor supply.