Transfer Programs, Tax
Rates, and Labor supply
Robert Moffitt
Johns Hopkins University
September 27, 2013
BFI 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
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…
2.
3. Young mothers returning to work after
having children
 Feasibility questions
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):
4.
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 lowwage 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 Moffitt
Johns Hopkins University
September 27, 2013
BFI Conference on Taxation