samlet årgang - Økonomisk Institut - Københavns Universitet

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Income gain from entry
T+B
Y
Y-T-B
CS
Government revenue
GR
DWL
E B
B
←
Labor
supply
Deadweight Loss
Consumer surplus
Employed
individuals
Figure 4a: Welfare cost of taxation with
extensive labor supply responses.
E A
NATIONALØKONOMISK TIDSSKRIFT 2005. NR. 3
Income gain from entry
Behavioral effect
Labor
supply
Mechanical effect
Employed
individuals
Figure 4b: Marginal welfare cost of
taxation with extensive labor supply responses.
participate, and small changes in labor market incentives will typically create small
adjustments in the number of employed workers. The combination of non-convexities
and heterogeneity enables us to explain discrete entry-exit behavior at the individual
level together with smooth changes in employment at the macro level. Here we present
a very simple framework, which illuminates the main insights. A more general analysis
is presented in Eissa et al. (2004).
Consider a group of individuals who all have the same hourly productivity/wage w.
For simplification, we disregard intensive labor supply responses and assume that all
individuals work some fixed number of hours, ¯ h, if they work at all. Those who are
working receive the same pre-tax earnings denoted by Y w ¯ h. The individuals face
fixed work costs, which may reflect monetary costs, time costs or simply a fixed disutility
of working. These work costs are assumed to vary (smoothly) across individuals,
thereby giving rise to the upward sloping labor supply curve in Figure 4a. This curve
displays the number of employed individuals as a function of the net income gain of
working (i.e., earnings net of taxes paid and transfers lost). At a low net income gain,
many individuals stay outside the labor market because their work costs outweigh the
gain from entry. As the net income gain increases, more and more individuals find it
worthwhile to enter the labor market so as to generate a positively sloped extensive
labor supply curve.
With no tax-transfer system, the equilibrium would be at point A. Assume now that
an employed who is earning Y has to pay an amount T in taxes (net of any benefits),
while a non-employed individual receives the amount B in welfare benefits (net of
any taxes). This implies that the net income gain of working equals Y – T – B, thereby
T+B
Y
Y-T-B
CS
GR
B
C
DWL