Employment, Hours of Work and the OptimalTaxation of Low Income Families

The optimal design of low income support is examined using a structural labour supplymodel. The approach incorporates unobserved heterogeneity, fixed costs of work, childcarecosts and the detailed non-convexities of the tax and transfer system. The analysis considerspurely Pareto improving reforms and also optimal design under social welfare functions withdifferent degrees of inequality aversion. We explore the gains from tagging and also examinethe case for the use of hours-contingent payments. Using the tax schedule for lone parents inthe UK as our policy environment, the results point to a reformed non-linear tax schedule withtax credits only optimal for low earners. The results also suggest a welfare improving role fortagging according to child age and for hours-contingent payments, although the case for thelatter is mitigated when hours cannot be monitored or recorded accurately by the taxauthorities....