samlet årgang - Økonomisk Institut - Københavns Universitet

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NATIONALØKONOMISK TIDSSKRIFT 2005. NR. 3
reacts by making a discrete jump from not working at all to working nearly as many
hours as individual 1 (at point B 2 ). This discreteness of the participation choice is consistent
with empirical distributions of hours worked. Hence, the incorporation of fixed
work costs allows for a more realistic model of participation behavior. 3
To summarize, we note that tax reforms entail intensive as well as extensive labor
supply responses, and to account for the observed discreteness of extensive responses,
they have to be modeled by introducing non-convexities into the standard framework.
3. The excess burden of taxation
In general, the tax system affects labor supply along both the intensive and extensive
margins. These distortionary effects on labor supply affect government revenue and
give rise to a loss of economic efficiency. This is what we call the excess burden or the
deadweight loss of taxation. The aim of this section is to explain why it is important to
distinguish explicitly between the intensive margin and the extensive margin when
trying to measure the excess burden of taxation. Notice that it is not obvious a priori
that we need to distinguish between the two margins in order to quantify the efficiency
cost of the tax system. Taxes distort labor supply along both dimensions, but maybe
this could be captured simply by looking at the aggregate labor supply curve thereby
incorporating both the intensive margin effect and the extensive margin effect in a
single relationship. Although this reasoning may sound plausible, it turns out to be
wrong, as we will show below.
3.1 The excess burden of taxation with intensive labor supply responses
We start with a review of the standard deadweight loss of taxation, which focuses
only on the intensive labor supply margin. Consider an individual with an hourly
productivity/wage of w. For simplicity, assume that the individual faces a simple proportional
tax scheme where m denotes the marginal tax rate. The individual is willing
to work more hours at a higher after-tax wage rate thereby giving rise to the upwardsloping
labor supply curve illustrated in Figure 3a. With no taxes, the labor market
would be at point A. The impact of the tax system is to reduce the hourly take-home
wage from w to (1 – m) w, thereby giving rise to an equilibrium at point B.
At point B, the individual obtains a consumer surplus given by the area CS, the
government revenue is given by the area labeled GR, while the triangle DWL captures
the deadweight loss from the tax. The deadweight loss measures the amount that is
3. In addition to fixed work costs, the presence of low-income support programs featuring gradual phase-out
and possibly discrete earnings and work tests create non-convexities making low hours of work very
unattractive. In fact, Figure 2 can easily be reinterpreted to illustrate the case of non-convex tax-transfer
programs by thinking of the cost y f as an out-of-work welfare benefit, which is lost upon entry.