Evaluation of Four Tax Reforms in the United States: Labor Supply and Welfare Effects for Single Mothers

Abstract

A large literature evaluating the welfare effects of taxation has examined the role of the labor supply elasticity, and has shown that the estimated welfare effects are highly sensitive to its size. A common feature of this literature is its exclusive focus on hours worked and the associated marginal tax rate. An emerging consensus among public finance and labor economists, however, is that labor supply is more responsive along the extensive margin (participation) than along the intensive margin (hours worked). To understand the implications of the participation decision for the welfare analysis of tax reform, this paper embeds the extensive margin in an explicit welfare theoretic framework. It is shown that the participation effect on welfare is created by a different tax wedge than the marginaltax wedge relevant for hours of work. This difference is due to non-linearities and discontinuities in tax-transfer schemes, features that are particularly important for the welfare evaluation of tax reforms affecting the bottom of the income distribution. We apply our framework to examine the labor supply and welfare effects for single mothers in the United States following four tax acts passed in 1986, 1990, 1993, and 2001. Our simulations show that each of the four tax acts reduced the tax burden on low-income single mothers, and created substantial welfare gains. We note three features of the welfare effects. First, we find that welfare gains are almost exclusively concentrated along the extensive margin of labor supply. Second, welfare effects along the extensive margin tend to dominate those along the intensive margin, even when the two labor supply elasticities are of similar size. This occurs because the welfare effect on each margin is created by a different tax wedge. Finally, ignoring the composition of the labor supply elasticity may reverse the sign of the welfare effect. In the welfare evaluation of tax reform, we conclude that the composition of the total labor supply elasticity is as important as its size.

How incentives matter? An illustration from the targeted subsidies reform in Iran

“…The Rohani government then faces economic recession associated with dampened income inequality. 5 Columns 3 and 4 give the valuations obtained in the counterfactual experiment where only the local downward incentive pattern can bind. The theoretical rule (6) for optimal income taxes shows that the valuation of a mimicked type i (λ * ji > 0 for some j = i) is high compared to the situation where this type would be not envied (λ * ji = 0 for all j = i).…”

Single Mothers and Incentives to Work: The French Experience

“…Other previous studies that have looked into the effect of taxes and benefits on the labor supply of single mothers have focused on the US (Meyer and Rosembaum 2000, Eissa et al 2004) and the UK (Gregg and Harkness 2003, Ermish and Wright 1991, Jenkins 1992. The expansions of the EITC in the US have been shown to induce more single mothers to join the labor market, suggesting that single mothers' employment rates are responsive to financial incentives.…”

Declining Female Labor Supply Elasticities in the U.S. and Implications for Tax Policy: Evidence from Panel Data

“…In recent work, Saez (2002) and Eissa, Kleven, and Kreiner (2008) have shown that, not only the magnitude but also the composition of elasticities between the hours and participation margins matter for optimal taxes and their excess burden. Precise welfare simulations using this new insight have been conducted only for single women in the context of EITC (Eissa, Kleven, and Kreiner, 2008).…”

“…Precise welfare simulations using this new insight have been conducted only for single women in the context of EITC (Eissa, Kleven, and Kreiner, 2008). Tax policy implications based on single females' labor supply elasticities may not apply to married females because the two groups' labor market behavior significantly differs.…”

“…First, the paper uses panel data on married women from the Panel Study of Income Dynamics (PSID) covering almost three decades (from 1980-2006) to mitigate concerns regarding unobserved heterogeneity and to reexamine recent crosssectional evidence that female labor supply elasticities have declined. Second, based on estimates of time-varying elasticities and employing a method proposed in Eissa, Kleven, and Kreiner (2008), the paper simulates the welfare effects on married females of tax policy changes, from six major tax reforms since 1980 by explicitly accounting for both the participation and the hours margin responses.…”