INCENTIVE AND INSURANCE EFFECTS OF INCOME TAXATION
Article first published online: 2 MAY 2013
© 2013 The Author. Bulletin of Economic Research © 2013 John Wiley & Sons Ltd and the Board of Trustees of the Bulletin of Economic Research
Bulletin of Economic Research
How to Cite
Andersen, T. M. (2013), INCENTIVE AND INSURANCE EFFECTS OF INCOME TAXATION. Bulletin of Economic Research. doi: 10.1111/boer.12006
- Article first published online: 2 MAY 2013
Tax distortions cause a trade-off between efficiency and equity. However, taxes not only affect incentives; they also provide implicit insurance, and this may critically affect the efficiency–equity relationship. For a standard labour supply problem it is shown that the insurance effect mutes the sensitivity of labour supply to taxes, which tends to reduce tax distortions and lower the marginal costs of public funds. The relation between incentives and insurance and thus efficiency and equity is flattened by the insurance effect and it may even be non-monotone. However, the optimal utilitarian policy implies that there is always a trade-off between efficiency and equity on the margin.