Income Taxation with Frictional Labor Supply

Abstract

I study nonlinear income taxation in a dynamic environment where individual labor supply is subject to frictions, e.g., hours constraints within firms. Specifically, consistent with the empirical evidence, agents incur a fixed cost of adjusting their hours of work in response to wage or tax changes. This generates an endogenous extensive margin of labor supply, conditional on participation. I derive a formula that characterizes the optimal long-run progressive tax schedule in this economy, and show in particular that the standard frictionless models, which ignore the lumpiness of labor supply, underestimate the long-run costs of raising tax progressivity.

Reference

Nicolas Werquin (Toulouse School of Economics), “Income Taxation with Frictional Labor Supply”, Third Taxation Theory Conference, Manufacture des Tabacs, Toulouse, France, May 26–27, 2016, room MS 001.