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The Estimation of Labor Supply Over Kinked Budget Constraints: Some New Econometric Methodology

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  • Anthony J. Pellechio

Abstract

Most programs of taxation and income maintenance imply that the tax rate faced by an individual changes at different levels of labor supply. As a result, the individual's budget constraint is kinked which presents problems for the empirical study of labor supply. This paper develops econometric methodology for estimating labor supply in the presence of taxes. Equations for market wage and shadow price are used to describe labor supply choices over a kinked budget constraint This approach makes a distinction between the discrete choice of which segment or corner of the kinked constraint to work on and the selection of the actual number of hours of work along linear segments. A consistent procedure is derived that uses all the tax rates faced by the individual and relies on no more structure than has been used in the previous literature on labor force participation. This procedure summarizes the individual's kinked budget constraint by calculating the expected value of variables that assume different values on the sections of the constraint. Techniques for estimating the model based on a probit analysis of the decision to work above or below certain corners of the budget constraint are presented. Maximum likelihood estimation is also discussed.

Suggested Citation

  • Anthony J. Pellechio, 1979. "The Estimation of Labor Supply Over Kinked Budget Constraints: Some New Econometric Methodology," NBER Working Papers 0387, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:0387
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    1. Zabalza, A. & Pissarides, C. & Barton, M., 1980. "Social security and the choice between full-time work, part-time work and retirement," Journal of Public Economics, Elsevier, vol. 14(2), pages 245-276, October.
    2. Heckman, James, 2013. "Sample selection bias as a specification error," Applied Econometrics, Russian Presidential Academy of National Economy and Public Administration (RANEPA), vol. 31(3), pages 129-137.
    3. Keeley, Michael C, et al, 1978. "The Estimation of Labor Supply Models Using Experimental Data," American Economic Review, American Economic Association, vol. 68(5), pages 873-887, December.
    4. Jerry A. Hausman, 1980. "The Effect of Wages, Taxes, and Fixed Costs on Women's Labor Force Participation," NBER Chapters, in: Econometric Studies in Public Finance, pages 161-194, National Bureau of Economic Research, Inc.
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    Cited by:

    1. James J. Heckman & Thomas E. MaCurdy, 1982. "New Methods for Estimating Labor Supply Functions: A Survey," NBER Working Papers 0858, National Bureau of Economic Research, Inc.
    2. Anthony J. Pellechio, 1981. "Social Security and the Decision to Retire," NBER Working Papers 0734, National Bureau of Economic Research, Inc.

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