On the Optimal Design of Income Transfer Programs: A Dynamic Perspective

Abstract

I analyse optimal income transfer programs from a dynamic perspective within a stylised two-period model with extensive labor supply responses and add two features to the standard static model. First, human capital acquired by working increases future productivity. Second, working in the first period creates a higher attachment to the labor market via lower opportunity costs of work in the future. I derive the optimal participation tax formula of each period and express them in terms of sufficient statistics, i.e. semi-elasticities, social marginal welfare weights and dynamic fiscal revenue effects. I show that in income ranges, in which workers – by getting more productive – pay more taxes in period two compared to period one, in-work benefits will be partly self-financing. This especially implies compressed phase-in regions and longer phase-out regions of in-work benefits in the optimal tax schedule.

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David Koll
Postdoctoral Scholar, University of Mannheim