A Simulation-Based Welfare Loss Calculation for Labor Taxes with Piecewise-Linear Budgets

34 Pages Posted: 11 Dec 2003 Last revised: 16 Sep 2010

See all articles by Don Fullerton

Don Fullerton

University of Illinois at Urbana-Champaign - Department of Finance; National Bureau of Economic Research (NBER); CESifo (Center for Economic Studies and Ifo Institute)

Li Gan

Texas A&M University - Department of Economics; National Bureau of Economic Research (NBER)

Date Written: December 2003

Abstract

Graduated income tax rates and transfer programs create piecewise-linear budget constraints that consist of budget segments and kink points. With any change in these tax rules, each individual may switch between a kink point and a budget segment, between two budget segments, or between two kink points. With errors in the estimated labor supply equation, the new choice is uncertain, and so the welfare effects of a tax change are uncertain. We propose a simulation-based method to compute expected welfare effects that is easy to implement and that fully accounts for uncertainties about choices around kink points. Our method also provides information about expected changes in working hours.

Suggested Citation

Fullerton, Don and Gan, Li, A Simulation-Based Welfare Loss Calculation for Labor Taxes with Piecewise-Linear Budgets (December 2003). NBER Working Paper No. w10139. Available at SSRN: https://ssrn.com/abstract=476096

Don Fullerton (Contact Author)

University of Illinois at Urbana-Champaign - Department of Finance ( email )

1206 South Sixth Street
Champaign, IL 61820
United States
(217) 244-3621 (Phone)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

Li Gan

Texas A&M University - Department of Economics ( email )

5201 University Blvd.
College Station, TX 77843-4228
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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