Labour Supply Incentives in Alternative Tax and Transfer Schemes: A Diagrammatic Introduction

New Zealand Treasury Working Paper 03/08

Published June 2003

Author: John Creedy

Abstract

The aim of this paper is to illustrate some of the complexities involved in modelling the incentive effects of taxes and transfers, using only basic diagrammatic methods. It describes a range of diagrams which are helpful in thinking about the design of tax and transfer systems and their potential effects on labour supply behaviour. Emphasis is given to the role of highly nonlinear budget constraints and the resulting wide range of labour supply responses.

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Abstract Table of Contents List of Figures 1 Introduction 2 Net and gross incomes 2.1 A basic income – flat tax 2.2 Means-tested benefits 3 Taxes and labour supply 3.1 The framework of analysis 3.2 The basic income – flat tax 4 Piecewise-linear budget constraints 4.1 A convex budget set 4.2 A non-convex budget set 4.3 A multi-rate tax structure 5 Benefit take-up 6 Conclusion References	twp03-08.pdf (226 KB) pp. 1–22
List of Figures Figure 1 – Net and gross income Figure 2 – A basic income - flat tax Figure 3 – Marginal and average tax rates Figure 4 – A tax-free threshold Figure 5 – A typical multi-rate system Figure 6 – An indifference map Figure 7 – Individual budget constraint: BI/FT Figure 8 – Wages and hours worked Figure 9 – Labour supply with the BI/FT Figure 10 – A convex budget set Figure 11 – A corner solution Figure 12 – Gross earnings and the wage rate Figure 13 – Labour supply curve Figure 14 – Means-testing: A non-convex budget set Figure 15 – Gross earnings and the wage rate Figure 16 – Labour supply curve Figure 17 – Corner and tangency solutions Figure 18 – Gross earnings and the wage rate Figure 19 – Fixed costs of working Figure 20 – A multi-rate system Figure 21 – Multiple local optima Figure 22 – Labour supply curve with multi-rate tax system Figure 23 – Alternative labour supply curve Figure 24 – Another alternative labour supply curve Figure 25 – A fixed cost of claiming a benefit Figure 26 – Earnings with incomplete take-up

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Abstract

List of Figures

1 Introduction

2 Net and gross incomes

3 Taxes and labour supply

4 Piecewise-linear budget constraints

5 Benefit take-up

6 Conclusion

References

twp03-08.pdf (226 KB) pp. 1–22

List of Figures

Acknowledgements

I am grateful to Nilss Olekalns, Guyonne Kalb, Veronica Jacobsen and Nathan McClellan for helpful comments on earlier drafts.

Disclaimer

The views expressed in this Working Paper are those of the author(s) and do not necessarily reflect the views of the New Zealand Treasury. The paper is presented not as policy, but with a view to inform and stimulate wider debate.

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Labour Supply Incentives in Alternative Tax and Transfer Schemes: A Diagrammatic Introduction

Abstract

Contents

Abstract

Table of Contents

List of Figures

1 Introduction

2 Net and gross incomes

3 Taxes and labour supply

4 Piecewise-linear budget constraints

5 Benefit take-up

6 Conclusion

References

List of Figures

Acknowledgements

Disclaimer