The Effect of Income Taxation on Consumption and Labor Supply

Posted: 16 Apr 2011

See all articles by James P. Ziliak

James P. Ziliak

University of Kentucky - Department of Economics

Thomas J. Kniesner

Claremont Graduate University - Department of Economic Sciences; Syracuse University - Department of Economics; IZA

Date Written: November 1, 2004

Abstract

We estimate the incentive effects of income taxation in a life-cycle model of consumption and labor supply that relaxes the standard assumption of strong separability within periods. Our model permits identification of both within-period preference parameters and life-cycle preference parameters such as the inter-temporal substitution elasticity. Results indicate that consumption and hours worked are direct complements in utility, and both increase with an increase in the after-tax share and with a compensated increase in the net wage. The compensated net wage elasticity is about 0.3, nearly double the standard estimates for men in the United States that ignore within-period non-separability between consumption and hours and rely on linear preferences. Given our estimated inter-temporal elasticity of substitution of about -0.96, the Frisch specific substitution elasticities of consumption and labor supply with respect to the after-tax wage are about 0.1 and 0.5, indicating significant inter-temporal smoothing of utility. Depending on consumption measure, static estimates of the marginal welfare cost of revenue-neutral taxation are 6-20 percent, which is about half the estimated welfare cost when additivity between consumption and leisure is incorrectly imposed.

JEL Classification: J22, H21, H24

Suggested Citation

Ziliak, James P. and Kniesner, Thomas J., The Effect of Income Taxation on Consumption and Labor Supply (November 1, 2004). Journal of Labor Economics, Forthcoming, Available at SSRN: https://ssrn.com/abstract=1809893

James P. Ziliak

University of Kentucky - Department of Economics ( email )

Lexington, KY 40506
United States

Thomas J. Kniesner (Contact Author)

Claremont Graduate University - Department of Economic Sciences ( email )

Claremont, CA 91711
United States

Syracuse University - Department of Economics ( email )

Syracuse, NY 13244-1020
United States

IZA

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

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