samlet årgang - Økonomisk Institut - Københavns Universitet

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NATIONALØKONOMISK TIDSSKRIFT 2005. NR. 3
line scenario equals -0.38, whereas the welfare effect equals 2.30 when including the
extensive welfare effect. We may instead try to estimate the welfare effect from the
traditional, convex model by substituting the aggregate labor supply elasticity for the
hours-of-work elasticity, i.e., apply expression (7). This gives a welfare estimate of
-1.88 which should be contrasted with the 2.30 obtained when accounting properly for
the extensive welfare effect. These numbers demonstrate clearly the large errors that
may arise from basing the evaluation of tax reforms on the traditional, convex labor
supply model.
The errors reflect that the two margins of labor supply response depend on taxes
and transfers in different ways. While the intensive margin depends on the effective
marginal tax rate, the extensive margin is related to the average tax rate and the benefit
rate. By implication, the size of the error depends crucially on the properties of the
tax-transfer programs being analyzed.
5. The optimal design of redistributional policies
The proper amount of redistribution and the design of transfer programs is an important
and controversial issue in the political sphere. As is well known from the theory
of optimal income taxation, redistribution gives rise to a trade-off between equity
and efficiency. Redistribution from middle and high incomes to low incomes is desirable
for equity reasons. On the other hand, redistributive programs tend to reduce labor
supply incentives, thereby creating efficiency costs.
In this section, we first discuss the implications of the recent evidence on labor supply
behavior for the theory of optimal income taxation. Secondly, we analyze empirically
the tradeoff between equity and efficiency in redistribution policy across different
EU countries. Thirdly, we discuss some implications for the tax treatment of
married couples.
5.1 The optimal income tax
Following the seminal contribution by James A. Mirrlees (1971) most of the literature
exploring the optimal income tax structure has applied the standard, convex
labor supply model. One of the lessons from this literature is that marginal tax rates
should be positive at all earnings levels. 17 By implication, a tax-transfer system involving
an EITC creating negative tax rates at the bottom of the earnings distribution is
never optimal. In a recent interesting contribution, Saez (2002) shows theoretically
that this result breaks down if all (or most) of the variation in labor supply occurs along
the extensive margin rather than on the intensive margin. His calibration of a general
17. Kleven and Kreiner (2004a) provides a short review of the standard results in the theory of optimal income
taxation.