Description:
This chapter discusses taxes and labor supply. The effect of taxes on labor supply introduces interesting questions in economic theory, econometrics, and public finance. Since the greatest share of federal tax revenue, approximately 50 in 1980, is raised by the individual income tax. The federal income tax is based on the notion of ability to pay, and its progressive structure has received wide acceptance. To measure empirically the effect of taxes on labor supply, problems in economic theory and econometrics need to be treated. First, the effect of progressive taxation is to create a convex, non-linear budget set where the net, after-tax wage depends on hours worked. Since most of consumer theory is based on constant market prices which are independent of quantity purchased, theoretical notions such as the Slutsky equation need to be modified to assess the effect of a change in the tax rate. The other important aspect of the taxation of labor supply is the effect on economic welfare.