Employment, Hours of Work and the Optimal Design of Earned Income Tax Credits

Posted: 25 Nov 2008  

Richard W. Blundell

UCL; IFS; IZA Institute of Labor Economics; Centre for Economic Policy Research (CEPR)

Date Written: November 25, 2008

Abstract

This paper examines the optimal schedule of marginal tax rates and the design of earned income tax credits. The analysis is based on a structural labour supply model which incorporates unobserved heterogeneity, fixed costs of work and the detailed non-convexities of the tax and welfare system. An analytical framework is developed that allows explicitly for an extensive margin in work choices and also the partial observability of hours of work. This is contrasted to the standard case in which only earnings (and non-labour income) are observable to the government. The empirical motivation is the earned income tax credit reforms in Britain which include a minimum hours requirement at 16 hours per week and a further bonus at 30 hours. Our analysis examines the case for the use of hours-contingent payments and lends support for the overall structure of the tax credit reforms. However, we also provide a strong case for a further reduction of marginal rates for lower earners but only those with school age children.

Keywords: labour supply, taxation, optimal taxation

JEL Classification: H21, H31, J21, J22

Suggested Citation

Blundell, Richard W., Employment, Hours of Work and the Optimal Design of Earned Income Tax Credits (November 25, 2008). Available at SSRN: https://ssrn.com/abstract=1307242

Richard W. Blundell (Contact Author)

UCL ( email )

Department of Economics
Gower Street
London, WC1E 6BT
United Kingdom
+44 20 7504 5863 (Phone)
+44 20 7916 2773 (Fax)

HOME PAGE: http://www.ucl.ac.uk/~uctp39a/

IFS

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London, WC1E 7AE
United Kingdom

HOME PAGE: http://www.ifs.org.uk

IZA Institute of Labor Economics

P.O. Box 7240
Bonn, D-53072
Germany

Centre for Economic Policy Research (CEPR)

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

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