6 - Labor supply, taxes, and transfers

Summary

In this chapter, I discuss the labor supply effects of taxes and transfer payments. This topic is interesting and important because it raises a variety of challenging theoretical and empirical issues and is at the center of intense and sometimes emotional controversies about the role, scope, and consequences of an extensive and complex set of government programs. Moreover, for a variety of reasons – including, in particular, the ones just noted – in recent years government agencies and other bodies have provided extensive funding for research on the relation between labor supply, taxes, and transfers. Thus, economists have had strong pecuniary incentives (as well as strong intellectual incentives) to investigate such matters. It is no exaggeration to say, as Ashenfelter (1978c, p. 109) does, that “measuring labor supply behavior … is now big business and I can think of more than one organization whose capital value would shrink if the subject became moribund.”

The first order of business in a discussion of taxes and transfers and their effects on labor supply should be to develop an analytical framework for use in theoretical and empirical inquiry. After setting up such a framework, I will then discuss the labor supply effects of five main kinds of tax and transfer programs: the income tax, cash transfer programs (including both programs now in existence and proposed negative income tax schemes), the Social Security system, in-kind transfer programs, and, finally, wage subsidy schemes.