samlet årgang - Økonomisk Institut - Københavns Universitet

LABOR SUPPLY BEHAVIOR AND THE DESIGN OF TAX AND TRANSFER POLICY 325
Like the EITC, this program was designed to induce low-income people with children,
typically single mothers, from welfare into work. Their results indicate that the reform
was quite effective in achieving this goal, increasing the participation rate of single
women with children by 2.2 percentage points (5 percent).
While the literature on labor supply in Anglo-Saxon countries is extensive, there are
fewer studies for continental European and Scandinavian countries. One might expect
that labor supply elasticities are smaller in the more rigid labor markets of continental
Europe and Scandinavia. However, several recent studies suggest that this is not the
case. A number of structural studies of female labor supply are surveyed in Blundell
and MaCurdy (1999). These studies found high elasticities – typically between 0.5 and
1 – across a number of European countries such as Germany, the Netherlands, France,
Italy, Sweden, and the UK. 1 Since these results were based on samples containing nonemployed
individuals, the participation response is included in the estimated elasticities.
Indeed, the results probably reflect an underlying labor supply curve where elasticities
are large around the point of participation but fall off rapidly with increases in working
hours, Blundell (1995).
The finding that tax incentives may have substantial effects on labor force participation
is consistent with another stream of empirical literature estimating the effect of
out-of-work benefits on unemployment. Krueger and Meyer (2002) surveys the evidence
from a number of OECD countries. They conclude that benefits raise the incidence
and the duration of unemployment, and that the elasticity of lost work time
with respect to benefits tends to be around one. Since the risk of unemployment is largest
among low-skilled workers, this evidence also indicates that strong participation
responses tend to be concentrated at the bottom of the wage distribution.
2.2 Modeling entry-exit behavior in the labor market
Having established that extensive labor supply responses are empirically important,
we wish to explore their implications for the welfare evaluation of tax and transfer
policy. In order to do so, we have to think about how to model participation behavior.
As emphasized by Eissa et al. (2004), a realistic model must be consistent with empirical
distributions of hours worked showing almost no workers at low annual or weekly
hours of work. In other words, if individuals decide to work at all, they tend to work
a substantial number of hours (say, 30 or 40 hours per week). To explain this discreteness
of participation behavior, we need a framework featuring non-convexities in
1. We are not aware of studies estimating the elasticity of labor force participation with respect to taxes for
Denmark. While the results for Sweden may give some indication of labor supply behavior in Denmark, it
would be interesting and important to carry out econometric studies based on Danish data and reforms in order
to discuss the design of future tax and welfare reforms in this country.