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Optimal income taxation with labor supply responses at two margins: When is an Earned Income Tax Credit optimal?

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  • Hansen, Emanuel

Abstract

This paper studies optimal non-linear income taxation in a model with labor supply responses at the intensive (hours, effort) and extensive (participation) margins. It shows that an Earned Income Tax Credit (EITC) with negative marginal taxes and negative participation taxes at the bottom is optimal if, first, semi-elasticities of participation are decreasing along the income distribution and, second, social concerns for redistribution from the poor to the very poor are sufficiently weak. This result is driven by a previously neglected trade-off between distortions at the intensive margin and distortions at the extensive margin, i.e., between two aspects of efficiency. Numerical simulations suggest that a strong expansion of the EITC for childless singles in the US could be welfare-increasing.

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  • Hansen, Emanuel, 2021. "Optimal income taxation with labor supply responses at two margins: When is an Earned Income Tax Credit optimal?," Journal of Public Economics, Elsevier, vol. 195(C).
    • Handle: RePEc:eee:pubeco:v:195:y:2021:i:c:s0047272721000013
    DOI: 10.1016/j.jpubeco.2021.104365
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    Cited by:

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    3. Albert Jan Hummel, 2021. "Unemployment and Tax Design," CESifo Working Paper Series 9177, CESifo.
    4. Kindermann, Fabian & Pueschel, Veronika, 2021. "Progressive Pensions as an Incentive for Labor Force Participation," CEPR Discussion Papers 16380, C.E.P.R. Discussion Papers.
    5. Marcus Berliant & Pierre C. Boyer, 2024. "Politics and income taxes: Progress and progressivity," Journal of Public Economic Theory, Association for Public Economic Theory, vol. 26(4), August.
    6. Albert Jan Hummel, 2021. "Unemployment and tax design," Tinbergen Institute Discussion Papers 21-061/VI, Tinbergen Institute.
    7. Charlotte Bartels & Cortnie Shupe, 2023. "Drivers of participation elasticities across Europe: gender or earner role within the household?," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 30(1), pages 167-214, February.
    8. Felix J. Bierbrauer & Pierre C. Boyer & Emanuel Hansen, 2023. "Pareto‐Improving Tax Reforms and the Earned Income Tax Credit," Econometrica, Econometric Society, vol. 91(3), pages 1077-1103, May.
    9. Silvia Rocha-Akis & Jürgen Bierbaumer & Benjamin Bittschi & Julia Bock-Schappelwein & Martina Einsiedl & Marian Fink & Michael Klien & Simon Loretz & Christine Mayrhuber, 2023. "Umverteilung durch den Staat in Österreich 2019 und Entwicklungen von 2005 bis 2019," WIFO Studies, WIFO, number 69741.
    10. Felix Bierbrauer & Pierre Boyer & Emanuel Hansen, 2023. "Fantastic tax cuts and where to find them," ECONtribute Policy Brief Series 051, University of Bonn and University of Cologne, Germany.
    11. Liu, Guanchun & Liu, Hangjuan & Liu, Yuanyuan & Yang, Jinyu & Zhang, Yanren, 2024. "Personal income tax and corporate innovation: The key role of inventors’ financial incentives," Journal of Banking & Finance, Elsevier, vol. 164(C).
    12. Hummel, Albert Jan & Jacobs, Bas, 2023. "Optimal income taxation in unionized labor markets," Journal of Public Economics, Elsevier, vol. 220(C).

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    More about this item

    Keywords

    Optimal income taxation; Extensive margin; Intensive margin; Earned Income Tax Credit;
    All these keywords.

    JEL classification:

    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation
    • H23 - Public Economics - - Taxation, Subsidies, and Revenue - - - Externalities; Redistributive Effects; Environmental Taxes and Subsidies
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design

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