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Optimal redistribution and monitoring of labor effort

Zoutman, Floris T.; Jacobs, Bas
Working paper
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URI
http://hdl.handle.net/11250/223706
Date
2014-09
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  • Discussion papers (FOR) [556]
Abstract
This paper extends the Mirrlees (1971) model of optimal non-linear income taxation with

a monitoring technology that allows the government to verify labor effort at a positive,

but non-infinite cost. We analyze the joint determination of the non-linear monitoring and

tax schedules and the conditions under which these can be implemented. Monitoring of

labor effort reduces the distortions created by income taxation and raises optimal marginal

tax rates, possibly above 100 percent. The optimal intensity of monitoring increases with

the marginal tax rate and the labor-supply elasticity. Our simulations demonstrate that

monitoring strongly alleviates the trade-off between equity and efficiency as welfare gains

of monitoring are around 1.4 percent of total output. The optimal intensity of monitoring

follows a U-shaped pattern, similar to that of optimal marginal tax rates. Our paper can

explain why large welfare states optimally rely on work-dependent tax credits, active labormarket

policies, benefit sanctions and work bonuses in welfare programs to redistribute

income efficiently.
Publisher
FOR
Series
Discussion paper;33/14

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