Income Maintenance and Labor Force Participation

Abstract

The paper studies the optimal tax-subsidy schedules in an economy where the only decision of the agents is to work, or not, with an application to the case of France. Given an income guarantee provided by the welfare state, the tax schedule that maximizes government revenue provides a benchmark, the Laffer bound, above which it is inefficient to tax. In fact, under mild conditions, a feasible allocation is second best optimal if and only if the associated taxes are lower than the Laffer bound. The only restriction that efficiency puts on the shape of the tax scheme is this upper Laffer bound. The Laffer tax scheme itself can be computed from the joint distribution of the agents' productivities and work opportunity costs. Depending on the economy, it can take widely different forms, and exhibit, for instance, negative marginal tax rates. After estimating the joint distribution of productivities and work opportunity costs on French data, I compute the Laffer bound for two subpopulations, single women and married women with two children or more. Quite surprisingly, the actual incentives to work appear to be very close to the bound.

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