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The marginal cost of public funds: hours of work versus labor force participation

Kleven, Henrik Jacobsen and Thustrup Kreiner, Claus (2006) The marginal cost of public funds: hours of work versus labor force participation. 5594. Centre for Economic Policy Research, London, UK.

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Abstract

This paper extends the theory and measurement of the marginal cost of public funds (MCF) to account for labor force participation responses. Our work is motivated by the emerging consensus in the empirical literature that extensive (participation) responses are more important than intensive (hours-of-work) responses. In the modelling of extensive responses, we argue that it is crucial to account for the presence of non-convexities created by fixed costs of work. In a non-convex framework, tax and transfer reforms give rise to discrete participation responses generating first-order effects on government revenue and the marginal cost of funds. Based on analytical expressions accounting for both margins of labor supply response, and allowing for heterogeneity in productivities and preferences, we calculate MCF for 15 European countries using micro data on taxes and benefits for each country. The MCF estimates depend crucially on the country under consideration and on the properties of the tax reform. In general, we find that extensive responses have very important effects on MCF, especially in the Scandinavian and the Central/Northern Continental European countries where participation tax rates are very high at the bottom of the distribution resulting from generous out-ofwork benefits along with high tax rates on workers. For these countries, the estimated MCFs centre around 2 in the case of proportional tax changes.

Item Type: Monograph (Discussion Paper)
Official URL: http://www.cepr.org
Additional Information: © 2006 Henrik Jacobsen Kleven and Claus Thustrup Kreiner
Library of Congress subject classification: H Social Sciences > HD Industries. Land use. Labor
H Social Sciences > HJ Public Finance
Journal of Economic Literature Classification System: H - Public Economics > H2 - Taxation, Subsidies, and Revenue > H21 - Efficiency; Optimal Taxation
H - Public Economics > H4 - Publicly Provided Goods > H41 - Public Goods
J - Labor and Demographic Economics > J2 - Time Allocation, Work Behavior, and Employment Determination and Creation; Human Capital; Retirement > J20 - General
Sets: Collections > Economists Online
Departments > Economics
Research centres and groups > Suntory and Toyota International Centres for Economics and Related Disciplines (STICERD)
Rights: http://www.lse.ac.uk/library/usingTheLibrary/academicSupport/OA/depositYourResearch.aspx
Identification Number: 5594
Date Deposited: 05 Jun 2008 10:10
URL: http://eprints.lse.ac.uk/5388/

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