IDEAS home Printed from https://ideas.repec.org/p/ces/ceswps/_2277.html
   My bibliography  Save this paper

Is Prescott Right? Welfare State Policies and the Incentives to Work, Learn and Retire

Author

Listed:
  • Bas Jacobs

Abstract

This paper bolsters Prescott’s (2004) claim that high taxes are responsible for lacklustre labor market performance in continental European countries. We develop a lifecycle model with endogenous skill formation, endogenous labor supply, and endogenous retirement. Labor taxation distorts not only labor supply, but also education and retirement decisions. Actuarially unfair pensions further exacerbate labor tax distortions on retirement. Education subsidies can nevertheless cushion the adverse impact of taxation on skill formation. Feedbacks between education, labor supply, and retirement are important. The model is simulated with realistic behavioral elasticities that are consistent with microeconometric evidence. If, besides labor supply, also learning and retirement are endogenous, the uncompensated (compensated) elasticity of the tax base equals 0.46 (0.85), which is more than twice as large as the standard uncompensated (compensated) labor supply elasticity of 0.18 (0.40). Furthermore, life-cycle interactions between education, working and retirement are quantitatively important and the interactions raise all behavioral elasticities substantially. For example, the uncompensated labor supply elasticity increases with one-half due to life-cycle interactions (to 0.26). We demonstrate that low European labor supply can be fully explained by taxation without relying on unrealistically high labor supply elasticities. Reducing labor market distortions, cutting benefit levels, lowering tax rates, and making (early) retirement actuarially fairer, therefore boosts labor supply, delays retirement, and stimulates skill formation. In addition, high education subsidies are needed in large welfare states to off-set explicit and implicit tax burdens on human capital investment.

Suggested Citation

  • Bas Jacobs, 2008. "Is Prescott Right? Welfare State Policies and the Incentives to Work, Learn and Retire," CESifo Working Paper Series 2277, CESifo.
  • Handle: RePEc:ces:ceswps:_2277
    as

    Download full text from publisher

    File URL: https://www.cesifo.org/DocDL/cesifo1_wp2277.pdf
    Download Restriction: no
    ---><---

    Other versions of this item:

    References listed on IDEAS

    as
    1. Charlot, Olivier & Decreuse, Bruno, 2010. "Over-education for the rich, under-education for the poor: A search-theoretic microfoundation," Labour Economics, Elsevier, vol. 17(6), pages 886-896, December.
    2. Eric French, 2005. "The Effects of Health, Wealth, and Wages on Labour Supply and Retirement Behaviour," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 72(2), pages 395-427.
    3. Rafael Lalive & Jan Van Ours & Josef Zweimuller, 2006. "How Changes in Financial Incentives Affect the Duration of Unemployment," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 73(4), pages 1009-1038.
    4. Romain Duval, 2004. "Retirement Behaviour in OECD Countries: Impact of Old-Age Pension Schemes and other Social Transfer Programmes," OECD Economic Studies, OECD Publishing, vol. 2003(2), pages 7-50.
    5. Gruber, Jon & Saez, Emmanuel, 2002. "The elasticity of taxable income: evidence and implications," Journal of Public Economics, Elsevier, vol. 84(1), pages 1-32, April.
    6. Alberto Alesina & Edward Glaeser & Bruce Sacerdote, 2005. "Work and Leisure in the U. S. and Europe: Why so Different?," Harvard Institute of Economic Research Working Papers 2068, Harvard - Institute of Economic Research.
    7. Hartog,Joop & Maassen van den Brink,Henriëtte (ed.), 2007. "Human Capital," Cambridge Books, Cambridge University Press, number 9780521873161, October.
    8. David A. Wise, 1989. "The Economics of Aging," NBER Books, National Bureau of Economic Research, Inc, number wise89-1.
    9. Angel de la Fuente & Rafael Doménech, 2006. "Human Capital in Growth Regressions: How Much Difference Does Data Quality Make?," Journal of the European Economic Association, MIT Press, vol. 4(1), pages 1-36, March.
    10. Edward C. Prescott, 2004. "Why do Americans work so much more than Europeans?," Quarterly Review, Federal Reserve Bank of Minneapolis, vol. 28(Jul), pages 2-13.
    11. David M. Blau, 2008. "Retirement and Consumption in a Life Cycle Model," Journal of Labor Economics, University of Chicago Press, vol. 26(1), pages 35-71.
    12. Lans Bovenberg, A. & Jacobs, Bas, 2005. "Redistribution and education subsidies are Siamese twins," Journal of Public Economics, Elsevier, vol. 89(11-12), pages 2005-2035, December.
    13. Blundell, Richard & Macurdy, Thomas, 1999. "Labor supply: A review of alternative approaches," Handbook of Labor Economics, in: O. Ashenfelter & D. Card (ed.), Handbook of Labor Economics, edition 1, volume 3, chapter 27, pages 1559-1695, Elsevier.
    14. Frederick VAN DER PLOEG, 2004. "DO SOCIAL POLICIES HARM EMPLOYMENT? Second-best effects of taxes and benefits on labor markets," Economics Working Papers ECO2004/11, European University Institute.
    15. Pissarides, Christopher A., 1998. "The impact of employment tax cuts on unemployment and wages; The role of unemployment benefits and tax structure," European Economic Review, Elsevier, vol. 42(1), pages 155-183, January.
    16. Stephen Nickell, 1997. "Unemployment and Labor Market Rigidities: Europe versus North America," Journal of Economic Perspectives, American Economic Association, vol. 11(3), pages 55-74, Summer.
    17. Trostel, Philip A, 1993. "The Effect of Taxation on Human Capital," Journal of Political Economy, University of Chicago Press, vol. 101(2), pages 327-350, April.
    18. Gustman, Alan L. & Steinmeier, Thomas L., 2005. "The social security early entitlement age in a structural model of retirement and wealth," Journal of Public Economics, Elsevier, vol. 89(2-3), pages 441-463, February.
    19. Emmanuel Saez, 2002. "Optimal Income Transfer Programs: Intensive versus Extensive Labor Supply Responses," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 117(3), pages 1039-1073.
    20. Jacob A. Mincer, 1974. "Schooling, Experience, and Earnings," NBER Books, National Bureau of Economic Research, Inc, number minc74-1.
    21. Lucas, Robert E, Jr, 1990. "Supply-Side Economics: An Analytical Review," Oxford Economic Papers, Oxford University Press, vol. 42(2), pages 293-316, April.
    22. Sorensen, Peter Birch, 1999. "Optimal tax progressivity in imperfect labour markets," Labour Economics, Elsevier, vol. 6(3), pages 435-452, September.
    23. Bas Jacobs, 2005. "Optimal Income Taxation with Endogenous Human Capital," Journal of Public Economic Theory, Association for Public Economic Theory, vol. 7(2), pages 295-315, May.
    24. Gary S. Becker, 1964. "Human Capital: A Theoretical and Empirical Analysis with Special Reference to Education, First Edition," NBER Books, National Bureau of Economic Research, Inc, number beck-5.
    25. van der Klaauw, Wilbert & Wolpin, Kenneth I., 2008. "Social security and the retirement and savings behavior of low-income households," Journal of Econometrics, Elsevier, vol. 145(1-2), pages 21-42, July.
    26. John P. Rust, 1989. "A Dynamic Programming Model of Retirement Behavior," NBER Chapters, in: The Economics of Aging, pages 359-404, National Bureau of Economic Research, Inc.
    27. Stock, James H & Wise, David A, 1990. "Pensions, the Option Value of Work, and Retirement," Econometrica, Econometric Society, vol. 58(5), pages 1151-1180, September.
    28. Jacobs, Bas, 2007. "Real options and human capital investment," Labour Economics, Elsevier, vol. 14(6), pages 913-925, December.
    29. Jacob A. Mincer, 1974. "Schooling and Earnings," NBER Chapters, in: Schooling, Experience, and Earnings, pages 41-63, National Bureau of Economic Research, Inc.
    30. Jonathan Gruber & David A. Wise, 1999. "Social Security and Retirement around the World," NBER Books, National Bureau of Economic Research, Inc, number grub99-1.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Been-Lon Chen & Mei Hsu & Chih-Fang Lai, 2015. "Relative Effects of Labour Taxes and Unemployment Benefits on Hours Worked Per Worker and Employment," Pacific Economic Review, Wiley Blackwell, vol. 20(2), pages 282-309, May.
    2. Bargain, Olivier & Orsini, Kristian & Peichl, Andreas, 2011. "Labor Supply Elasticities in Europe and the US," IZA Discussion Papers 5820, Institute of Labor Economics (IZA).
    3. Frank N. Caliendo & T. Scott Findley, 2020. "Myopia, education, and social security," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 27(3), pages 694-720, June.
    4. Andrés Rodríguez-Pose & Vassilis Tselios, 2012. "Welfare Regimes and the Incentives to Work and Get Educated," Environment and Planning A, , vol. 44(1), pages 125-149, January.
    5. Margit Schratzenstaller-Altzinger & Fanny Dellinger, 2017. "Genderdifferenzierte Lenkungswirkungen des Abgabensystems," WIFO Studies, WIFO, number 60797, April.
    6. Gustafsson, Johan, 2021. "Implications of Pension Illiteracy for Labor Supply and Redistribution," Umeå Economic Studies 993, Umeå University, Department of Economics.
    7. Chen, Been-Lon & Lai, Chih-Fang, 2015. "Effects of labor taxes and unemployment compensation on labor supply in a search model with an endogenous labor force," Journal of Macroeconomics, Elsevier, vol. 43(C), pages 300-317.
    8. repec:zbw:bofrdp:2008_021 is not listed on IDEAS
    9. Margaret K. McKeehan & George R. Zodrow, 2019. "Balancing Act: Weighing the Factors Affecting the Taxation of Capital Income in a Small Open Economy," World Scientific Book Chapters, in: George R Zodrow (ed.), TAXATION IN THEORY AND PRACTICE Selected Essays of George R. Zodrow, chapter 12, pages 347-396, World Scientific Publishing Co. Pte. Ltd..
    10. Kinnunen, Helvi, 2008. "Government funds and demographic transition : alleviating ageing costs in a small open economy," Research Discussion Papers 21/2008, Bank of Finland.
    11. Gustafsson, Johan, 2021. "Public Pension Reform and the Equity-Efficiency Trade-off," Umeå Economic Studies 992, Umeå University, Department of Economics.
    12. Kinnunen, Helvi, 2008. "Government funds and demographic transition: alleviating ageing costs in a small open economy," Bank of Finland Research Discussion Papers 21/2008, Bank of Finland.
    13. Gustafsson, Johan, 2023. "Public pension reform with ill-informed individuals," Economic Modelling, Elsevier, vol. 121(C).
    14. Been-Lon Chen & Chih-Fang Lai, 2016. "Relative effects of labor taxes on employment and working hours: role of mechanisms shaping working hours," Journal of Economics, Springer, vol. 117(1), pages 49-84, January.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Heckman, James J. & Jacobs, Bas, 2009. "Policies to Create and Destroy Human Capital in Europe," IZA Discussion Papers 4680, Institute of Labor Economics (IZA).
    2. Blundell, R. & French, E. & Tetlow, G., 2016. "Retirement Incentives and Labor Supply," Handbook of the Economics of Population Aging, in: Piggott, John & Woodland, Alan (ed.), Handbook of the Economics of Population Aging, edition 1, volume 1, chapter 0, pages 457-566, Elsevier.
    3. Tito Boeri & Jan van Ours, 2013. "The Economics of Imperfect Labor Markets: Second Edition," Economics Books, Princeton University Press, edition 1, number 10142.
    4. Frank van Erp & Niels Vermeer & Daniel van Vuuren, 2013. "Non-financial determinants of retirement," CPB Discussion Paper 243.rdf, CPB Netherlands Bureau for Economic Policy Analysis.
    5. Frank van Erp & Niels Vermeer & Daniel van Vuuren, 2013. "Non-financial determinants of retirement," CPB Discussion Paper 243, CPB Netherlands Bureau for Economic Policy Analysis.
    6. Rob Euwals & Daniel Vuuren & Ronald Wolthoff, 2010. "Early Retirement Behaviour in the Netherlands: Evidence From a Policy Reform," De Economist, Springer, vol. 158(3), pages 209-236, September.
    7. Abdoulaye Ndiaye, 2017. "Flexible Retirement and Optimal Taxation," Working Paper Series WP-2018-18, Federal Reserve Bank of Chicago.
    8. Lalive, Rafael & Parrotta, Pierpaolo, 2017. "How does pension eligibility affect labor supply in couples?," Labour Economics, Elsevier, vol. 46(C), pages 177-188.
    9. Hugo Benítez-Silva & José Ignacio García-Pérez & Sergi Jiménez-Martín, 2014. "Reforming the U.S. Social Security system accounting for employment uncertainty," Economics Working Papers 1455, Department of Economics and Business, Universitat Pompeu Fabra.
    10. Alonso-Ortiz, Jorge, 2014. "Social security and retirement across the OECD," Journal of Economic Dynamics and Control, Elsevier, vol. 47(C), pages 300-316.
    11. Songül Tolan, 2017. "The Effect of Partial Retirement on Labor Supply, Public Balances and the Income Distribution: Evidence from a Structural Analysis," Discussion Papers of DIW Berlin 1679, DIW Berlin, German Institute for Economic Research.
    12. Michele Belloni & Rob Alessie, 2013. "Retirement Choices in Italy: What an Option Value Model Tells Us," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 75(4), pages 499-527, August.
    13. Hugo Benítez-Silva & J. Ignacio García-Pérez & Sergi Jiménez-Martín, 2011. "The effects of employment uncertainty and wealth shocks on the labor supply and claiming behavior of older American workers," Economics Working Papers 1275, Department of Economics and Business, Universitat Pompeu Fabra.
    14. Mathias Hungerbühler & Etienne Lehmann & Alexis Parmentier & Bruno Van Der Linden, 2006. "Optimal Redistributive Taxation in a Search Equilibrium Model," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 73(3), pages 743-767.
    15. Bound, John & Stinebrickner, Todd & Waidmann, Timothy, 2010. "Health, economic resources and the work decisions of older men," Journal of Econometrics, Elsevier, vol. 156(1), pages 106-129, May.
    16. Liebman, Jeffrey B. & Luttmer, Erzo F.P. & Seif, David G., 2009. "Labor supply responses to marginal Social Security benefits: Evidence from discontinuities," Journal of Public Economics, Elsevier, vol. 93(11-12), pages 1208-1223, December.
    17. Laun, Lisa, 2017. "The effect of age-targeted tax credits on labor force participation of older workers," Journal of Public Economics, Elsevier, vol. 152(C), pages 102-118.
    18. Dirk Schindler & Hongyan Yang, 2015. "Catalysts for social insurance: education subsidies versus physical capital taxation," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 22(2), pages 274-310, April.
    19. Alexis, PARMENTIER, 2006. "The effects of the marginal tax rate in a matching model with endogenous labor supply," Discussion Papers (ECON - Département des Sciences Economiques) 2006011, Université catholique de Louvain, Département des Sciences Economiques.
    20. Jorge González, 2008. "Commuting costs and labor force retirement," Working Papers. Serie AD 2008-19, Instituto Valenciano de Investigaciones Económicas, S.A. (Ivie).

    More about this item

    Keywords

    skill formation; human capital; labor supply; retirement; tax policy; benefit systems; pension policy; welfare state;
    All these keywords.

    JEL classification:

    • E20 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - General (includes Measurement and Data)
    • E60 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - General
    • H20 - Public Economics - - Taxation, Subsidies, and Revenue - - - General
    • H50 - Public Economics - - National Government Expenditures and Related Policies - - - General
    • I20 - Health, Education, and Welfare - - Education - - - General
    • I30 - Health, Education, and Welfare - - Welfare, Well-Being, and Poverty - - - General
    • J20 - Labor and Demographic Economics - - Demand and Supply of Labor - - - General

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:ces:ceswps:_2277. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Klaus Wohlrabe (email available below). General contact details of provider: https://edirc.repec.org/data/cesifde.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.