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Optimal income taxation with labor supply responses at two margins: When is an Earned Income Tax Credit optimal?

Emanuel Hansen ()
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Emanuel Hansen: University of Cologne

No 2017_10, Discussion Paper Series of the Max Planck Institute for Research on Collective Goods from Max Planck Institute for Research on Collective Goods

Abstract: This paper studies optimal non-linear income taxation in an empirically plausible model with labor supply responses at the intensive (hours, effort) and the extensive (participation) margin. In this model, redistributive taxation gives rise to a previously neglected trade-off between two aspects of effciency: To reduce the deadweight loss from distortions at the extensive margin, the social planner has to increase distortions at the intensive margin and vice versa. Due to this trade-off, minimizing the overall deadweight loss requires to distort labor supply by low-skill workers upwards at both margins. Building on these insights, the paper is the first to provide conditions under which social welfare is maximized by an Earned Income Tax Credit with negative marginal taxes and negative participation taxes at low income levels.

Keywords: Optimal income taxation; Extensive margin; Intensive margin (search for similar items in EconPapers)
JEL-codes: H21 H23 D82 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-dcm, nep-lma, nep-pbe and nep-pub
Date: 2017-05
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