Income and substitution effects of fiscal policy on work effort

The focus of this paper is twofold. First, it examines the impact on work effort of changes in government purchases financed with lump-sum taxes, in a neoclassical framework, with respect to four industrialised countries. Second, it reconsiders the expenditure-work effort relationship in a broader conceptual context that allows for distortionary taxation and a disaggregation of the income and substitution effects. Our findings are shown to cast doubt on the empirical plausibility of the prevailing (neoclassical and New Keynesian) models which seem to rely heavily on the lump-sum tax notion, thus ignoring the substitution effects of distortionary taxation.