Labor Supply, Income Taxes, and Hours Restrictions in the Netherlands

Abstract

In this paper, two models of individual labor supply are discussed. The first one is the by now classical Hausman-type model with convex piecewise linear budget constraints, in which both random preferences and optimization errors are incorporated by means of normally distributed random variables. Estimated coefficients are plausible but the model has the shortcoming that unemployment for males is not captured and that the simulated hours distribution misses the spikes in the sample distribution of working hours. Therefore, an alternative model is introduced which explicitly takes into account demand side restrictions on working hours. The difference with the standard model is the replacement of the optimization error by the assumption that each individual can choose from a finite set of wage hours packages and either picks the job offer yielding highest utility or decides not to work. It turns out that this model captures the sample distribution of working hours very well, for males as well as females. Wage and income elasticities according to the two models are similar and in line with other recent findings in The Netherlands. Dead weight loss calculations for the second model which explicitly take the hours restrictions into account, imply that the dead weight loss is much smaller than as calculated with the standard model.

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