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Labour Income Taxation

# Labour Income Taxation

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12/16/2012

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P
UBLIC
E
CONOMICS

L
ABOUR
I
NCOME
T
AX
When discussing
Labour Income Taxation
, we are primarily concernedwith
MARGINAL TAX RATES
.
T
he marginal tax rate is the derivative of the tax function (which is afunction of income (z):
A
P
ROGRESSIVE tax structure
is one where the marginal tax rate isincreasing in income (with apositive derivative)
.
A
F
LATE RATE tax structure
has a constant marginal tax (derivative is0)
.
A
REGRESSIVE tax structure
is one where the marginal tax rate isdecreasing in income (with anegative derivative)
.
We do not need to derive the optimal labour income tax, but the nextslides will focus on its ASSUMP
TION
S and RESUL
T
S
.
z  z  M
xx!
.

L
ABOUR
I
NCOME
T
AX
Assumptions:
P
ER
F
ECT COM
P
ETITION
Labour L is only factor of production
.

O
ne unit of effective labour provides oneunit of consumption good x (CRS):
L = x
Each household is characterised by theirSKILL LEVEL s.
T
his is their marginalproduct of labour, and is constant
.

I
tdetermines their labour supply
.
Skills are distributed within a finitebounding: S =[S1, S2]
.
Has a densityfunction
(s).
Income is therefore a function of the skilllevel
, and can be termed the 
E
FF
ECTIVELABOUR SU
PP
LY
:
Z(
s) = s.L
(
s)=s.x
N
ormalise the price of x to 1, and thewage is s:
Z(s) = s
Individuals maximise a quasi-concaveutility function subject to a budgetconstraint
:
Max: U(x, L(s))s
.
t: x(s) = s
.
L(s) 
T
(s
.
L(s))
T
(s
.
L(s)) =
T
(z(s))is the labour incometax
.
Governments aim to maximise aBERGENSON-SAMUELSON SOCIALWEL
F
ARE
F
UNCTION
, which is a
f
unctiono
f
individuals utilities only
, not nationalincome or income distribution (directly)
.

 
? A
  
? A
 
´´
!!
2121
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