Effects of income taxation and government spending policies on labor supply

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http://urn.fi/URN:NBN:fi:hulib-201703272743
Title: Effects of income taxation and government spending policies on labor supply
Author: Martinmäki, Vuokko
Other contributor: Helsingin yliopisto, Valtiotieteellinen tiedekunta, Politiikan ja talouden tutkimuksen laitos
University of Helsinki, Faculty of Social Sciences, Department of Political and Economic Studies
Helsingfors universitet, Statsvetenskapliga fakulteten, Institutionen för politik och ekonomi
Publisher: Helsingfors universitet
Date: 2014
Language: eng
URI: http://urn.fi/URN:NBN:fi:hulib-201703272743
http://hdl.handle.net/10138/135262
Thesis level: master's thesis
Discipline: Economics
Taloustiede
Ekonomi
Abstract: There are large differences in hours of market work between OECD countries. It has bees argued that taxes do account much of these differences and substantial part of differences in labor supply between United States and Continental Europe can in fact be explained by differences in tax rates. However, there are differences between labor supply between Scandinavia and Continental Europe that do not support this assumption since labor supply in Scandinavia is higher than in Continental Europe despite higher tax rates on labor income. The gap in labor supply between Scandinavia and Continental Europe stems from the differences in government spending programs, in other words, use of the tax revenues. Aim of my thesis is to explore the part of the differences in hours of market work that can be explained by differences in taxation and by use of the tax revenues. First part of the paper is conducted by exploring articles and models already made about the subject. For motivation I start by presenting differences in hours worked across OECD countries and how this has changed over time. In this thesis I am going to survey how government spending policies on productive purposes affect the hours of work supplied in market sector. Two applications of government spending considered are subsidies on the price of market services and subsidies on child care. The main research question is why people in Scandinavia are working more than could be concluded purely based on labor income tax rates and can this be explained by subsidies on work. In order to explain the effects of income taxes and government spending programs on hours of market work, I present standard real business cycle model with home production. In this model households do not only allocate their time between leisure and work, but also home work. This model allows us to explore the substitution into and out of market activity which is caused by fiscal variables like taxation and transfers that are affected by state of economy. First I am going to present simple model with lump-sum transfers and then add some fiscal policy applications to the model. These applications are subsidies on the price of market services and subsidies on child care, which are forms of government spending on productive purposes and subsidies on market work. In the last part of my thesis I will simulate the models constructed. These simulations are done by using Finland as an object of interest. Result from my simulations yield that based on my models constructed, the subsidies on work can explain why people in Scandinavia work more than could be suspected based on tax rates. Based on result from my simulations I can argue that differences in labor income taxes are not a sufficient explanation for the differences in hours of market work between economies. It can be concluded that the government spending on subsidizing work through supporting family and market services do at least partly offset the effect of income taxes.


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