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A Simulation-Based Welfare Loss Calculation for Labor Taxes with Piecewise-Linear Budgets

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  • Don Fullerton
  • Li Gan

Abstract

Graduated income tax rates and transfer programs create piecewise-linear budget constraints that consist of budget segments and kink points. With any change in these tax rules, each individual may switch between a kink point and a budget segment, between two budget segments, or between two kink points. With errors in the estimated labor supply equation, the new choice is uncertain, and so the welfare effects of a tax change are uncertain. We propose a simulation-based method to compute expected welfare effects that is easy to implement and that fully accounts for uncertainties about choices around kink points. Our method also provides information about expected changes in working hours.

Suggested Citation

  • Don Fullerton & Li Gan, 2003. "A Simulation-Based Welfare Loss Calculation for Labor Taxes with Piecewise-Linear Budgets," NBER Working Papers 10139, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:10139
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    Cited by:

    1. Gan, Li & Ju, Gaosheng & Zhu, Xi, 2015. "Nonparametric estimation of structural labor supply and exact welfare change under nonconvex piecewise-linear budget sets," Journal of Econometrics, Elsevier, vol. 188(2), pages 526-544.
    2. Eissa, Nada & Kleven, Henrik Jacobsen & Kreiner, Claus Thustrup, 2008. "Evaluation of four tax reforms in the United States: Labor supply and welfare effects for single mothers," Journal of Public Economics, Elsevier, vol. 92(3-4), pages 795-816, April.
    3. Stuart Adam, 2005. "Measuring the marginal efficiency cost of redistribution in the UK," IFS Working Papers W05/14, Institute for Fiscal Studies.
    4. Cristina Lopez-Mayan, 2014. "Microeconometric Analysis of Residential Water Demand," Environmental & Resource Economics, Springer;European Association of Environmental and Resource Economists, vol. 59(1), pages 137-166, September.
    5. Peter C. Reiss & Matthew W. White, 2006. "Evaluating Welfare with Nonlinear Prices," NBER Working Papers 12370, National Bureau of Economic Research, Inc.

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    JEL classification:

    • H2 - Public Economics - - Taxation, Subsidies, and Revenue
    • J2 - Labor and Demographic Economics - - Demand and Supply of Labor

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