Transfer Programs, Tax Rates, and Labor supply

Robert MoffittJohns Hopkins UniversitySeptember 27, 2013BFI Conference on Taxation

Will restrict myself to two topics

1. Transfer program design and labor supply

2. Commentary on Mirrlees Report proposals for reform of earnings taxation

1. Transfer Program Design and Labor Supply

Much of this will be familiar to those who have done research on this topic

But I have my own take on it Traditional issue: desire to keep the tax

rate on benefits low (negative income tax, Friedman and others) to encourage work effort

I think everybody wants that

Traditional problem is that lower tax rates, holding the guarantee fixed, increase expenditure and so you have to raise taxes on higher-income individuals to finance it

This is the problem posed, e.g., by the Brewer-Saez-Shephard Mirrlees Report chapter

They propose cutting the child benefit and raising other rates

Less recognized by many economists, much less the general public, is that reducing tax rates while holding guarantees fixed doesn’t necessarily even increase average labor supply “at the bottom”

More slightly higher income families are made eligible and they reduce labor supply

NIT experiment evidence and econometric evidence suggest the net effect is about zero (Moffitt, 2003)

Same is true of earnings subsidies like the EITC and the WFTC; because they have to be phased out, they reduce labor supply for some families and increase it for others

See Hotz and Scholz (2003) for supporting evidence

All these effects are incorporated into general optimal tax models but they are obscured

When thinking about welfare program design, I prefer to hold total welfare expenditure fixed and then talk about design

Can then focus on the issues of the distribution of tax rates and levels of guarantees among the “low” income population (e.g., $30K and below in the US)

If you do that, then reductions in t have to accompanied by reductions in G

Still have ambiguous labor supply effects but more likely to be positive

This was Milton Friedman’s recommendation in the first place

Have to focus on redistributional preferences (social weights) and LS elasticities for different groups w/in the low income population

And for earnings subsidies, have to reduce G to do those, too

I.e., you get more labor supply incentives at the bottom by instituting a regressive tax program

It also forces you to face the fundamental tradeoff between G and t

As a factual matter, UK and Europe tend to have high G and high t (see Brewer et al. for the extraordinarily high t’s in the UK) whereas the US has low Gs and low ts

(tax rates in US are very low: TANF is <.50, SNAP is probably < .10, housing is < .30, etc.; and EITC is negative)

In a country like the UK with its high Gs, reducing t can be very expensive

One possible solution to this tradeoff I think deserves more consideration: work requirements

Were anathema to Friedman and still are to many economists and policy people

But, like all Akerlof-style ‘tagging’ designs, it can be efficient to give high G only to those with (estimated) low mkt wages and low G to those with (estimated) high mkt wages—if (a big if) you can do a good job of estimating wage rates

But the question is whether real-world welfare administrators can do a halfway accurate job of estimating wages

Not clear See Mirrlees Report for a good discussion

of tagging designs And my Commentary on Brewer et al. for a

discussion; and my EJ (2006) paper for simulations of work requirements and error rates in wage estimation

2. Mirrlees Report Recommendations When I first read them, I could think only

one thing: Ramsey But instead of imposing lower excise taxes

on goods with more elastic demands, you impose lower income tax rates on those with greater labor supply elasticities

Ramsey excise taxation has not found wide acceptance (though perhaps because of distributional implications); I worry about these new proposals, too

Mirrlees Report thinks the evidence supports possibly high LS elasticities among

1. Young (or at education-leaving point?) 2. Old (or at retirement point?) 3. Women after having Children 4. High earners (income elasticities)

1. Young: seems quite plausible, we know that the age at which you start work is where a major change in lifetime labor supply has occurred over the last 60 years

Not sure about tax rates keyed specifically to school-leaving

2. Old: yes, I think Richard is talking about at pre-retirement ages

But, again, am not sure about cutting taxes for older workers who have not yet retired…

3. Young mothers returning to work after having children

Feasibility questions

4. High earners Yes, at the earnings margin rather than

hours margin Some evidence of mine for married men

before and after TRA86 (Moffitt and Wilhelm, 2000):

1983-1989 Change in AGI by Change in NTR (Feldstein (1995) method)

And I would add:

5. Low-wage men

Juhn-Murphy-Topel (1991): LS of low-wage men has fallen as their wages have fallen

Burtless (1987): NIT experiments showed that earnings reductions from NIT are 50% of the transfer cost

Who is left with inelastic labor supply curves? Mainly middle-age, middle-class men. Soak ‘em!

I worry about asking the political process to pick winners and losers; look what happens when you open the door to special-interest deductions

My first reaction is to stick with uniform taxation

Transfer programs, tax rates, and labor supply

Robert MoffittJohns Hopkins UniversitySeptember 27, 2013BFI Conference on Taxation