- Email: [email protected]
Quantitative evidence on the welfare effects of home sector fiscal policy
Economics Letters 118 (2013) 400–403
Contents lists available at SciVerse ScienceDirect
Economics Letters journal homepage: www.elsevier.com/locate/ecolet
Quantitative evidence on the welfare effects of home sector fiscal policy Kelly S. Ragan ∗ Stockholm School of Economics, Box 6501, 113 83 Stockholm, Sweden
article
info
Article history: Received 12 October 2012 Received in revised form 21 November 2012 Accepted 24 November 2012 Available online 12 December 2012
abstract A home production model that explicitly accounts for taxes and public expenditures on day-care and elder-care, substitutes for work households perform at home, is used to evaluate the welfare implications of alternative public expenditure policies. Both subsidy and workfare policies are welfare improving relative to a model where tax revenues are rebated lump sum. The welfare gains from optimal home sector policy design can be large. © 2012 Elsevier B.V. All rights reserved.
JEL classification: J22 E26 E62 Keywords: Home production Public expenditures Subsidy Workfare
1. Introduction Transfers of goods such as day-care and elder-care account for a sizable share of public expenditure in the O.E.C.D. Although important for matching labor supply patterns, the welfare implications of policies which subsidize or transfer market goods which substitute for time spent working at home are not well understood.1 I extend the analysis of the welfare consequences of public expenditure policies presented in Rosen (1996, 1997) to a general equilibrium setting and analyze policies from a broad set of countries. I investigate how the design of public expenditures and the magnitude of market sector taxes interact to affect welfare in a two-sector home production model. The policies modeled emphasize both the subsidy and workfare features of public expenditures discussed by Rosen (1996, 1997). Neither policy design is universally preferred. Instead, preferred home sector fiscal policies are shown to depend on the size of market sector tax distortions as well as the scale of public expenditures. In general, countries with low tax rates and low levels of public expenditure prefer subsidy policies, while countries with large market sector tax distortions and high public expenditure on home
∗
goods find it optimal to structure public expenditures as workfare transfers. Even holding constant tax and public expenditure levels, the scope for welfare improvement in the design of home sector fiscal policies is large. 2. Model Utility is an additively separable log utility specification defined over market goods, c, home services, s, and leisure, 1 − hm − hs , U (c , s, 1 − hm − hs ) = (1 − α1 )α2 log c + (1 − α1 )(1 − α2 ) log s
+ α1 log(1 − hm − hs ). There are two productive sectors, the market and the home sector. The household allocates labor to both. The household’s problem is to maximize utility subject to the budget constraint, the home production technology, and additional feasibility constraints on labor allocations (hm ≥ 0, hs ≥ 0, h = hm + hs ≤ 1). Market production is linear in labor, y = hm , and this output can be consumed directly, c, or used as an input into home services production, m.2 The aggregate feasibility constraint equates output to the sum of its uses, y = m + c. Home goods, s, are produced using household labor, hs , and market inputs, m. The government
Tel.: +46 76 3370703. E-mail address: [email protected].
1 See Ragan (2013), Ngai and Pissarides (2011), and Rogerson (2007) for quantitative evidence on the role of public expenditures in driving labor supply allocations in the O.E.C.D. 0165-1765/$ – see front matter © 2012 Elsevier B.V. All rights reserved. doi:10.1016/j.econlet.2012.11.030
2 Output is freely divisible. I do not specify alternative production functions for c and m, nor allow for sectoral productivity differences. In this regard market sector taxes, not productivity differences, lead to differences in the composition of output.
K.S. Ragan / Economics Letters 118 (2013) 400–403
raises revenues from market sector taxes on consumption and labor {τc , τh }, and whatever revenues are not spent on home sector policies are rebated to households in the form of a lump sum transfer denoted by T . Lump sum taxation is not allowed, T ≥ 0. The household’s problem is discussed under two alternative policy regimes. 2.1. Subsidy policy Subsidies of goods like day-care and elder-care, market goods which substitute for households’ own time in the production of home services, are captured by the subsidy ν . Given the policy quadruplet (τc , τh , ν, T ) the household solves the following problem: max
hm ,hs ,c ,m
U (c , s, 1 − h)
s = [amρ + (1 − a)hρs ]1/ρ hm ≥ 0 ,
hs ≥ 0,
h = hm + hs ≤ 1. Subsidies enter the household’s decision problem through the budget constraint as the price of a unit of m is only 1 − v . The government’s budget constraint equates expenditures in the form of lump sum transfers, T , and subsidies of market inputs to home production, v × m, to revenues from taxes on market sector labor and consumption: T + v m = τh hm + τc c .
(GBC1)
2.2. Workfare policy Rosen (1996) emphasized how benefits such as publicly provided day-care were closely tied to employment. To capture this link, public expenditures are modeled as transfers that are proportional to market work, φ hm , where φ denotes the transfer rate. Public transfers, φ hm , are a perfect substitute for m in the production of home services. Given the policy quadruplet (τc , τh , φ, T ) the household solves the following problem: max
hm ,hs ,c ,m
U (c , s, 1 − h)
s.t . (1 + τc )c + m = (1 − τh )hm + T s = [a (φ hm + m)ρ + (1 − a)hρs ]1/ρ m ≥ 0,
hm ≥ 0 ,
hs ≥ 0,
h = hm + hs ≤ 1. The workfare policy alters all three of the household’s first order conditions. With respect to the market work decision, there are now additional home sector returns to allocating labor to the market. The government budget constraint also includes in-kind transfers to households that are proportional to market work, T = (τh − φ)hm + τc c .
Table 1 Welfare comparison of expenditure equivalent policies.
US Spain UK Portugal Canada Italy France Belgium Germany Finland Sweden Norway Denmark
1+τc 1−τh
Subsidy
υ
CV
1.67 1.77 1.80 1.81 2.04 2.30 2.51 2.53 2.55 2.77 3.20 3.66 4.28
0.16 0.20 0.22 0.15 0.17 0.25 0.38 0.36 0.33 0.43 0.54 0.58 0.60
0.71 0.89 1.07 0.69 0.66 0.82 1.42 1.08 0.97 1.60 2.01 1.86 1.69
CV φ − CV ν
Workfare ν
φ
φ
CV
0.01 0.02 0.03 0.01 0.01 0.01 0.04 0.02 0.02 0.05 0.11 0.10 0.10
0.34 0.57 0.93 0.43 0.39 0.82 2.59 1.63 1.42 3.52 6.75 6.93 7.34
−0.37 −0.32 −0.14 −0.27 −0.26 0.00 1.17 0.55 0.45 1.92 4.74 5.07 5.65
Note: see Ragan (2013) for computation of the policy parameters and sources. CV ν is the percent increase in baseline consumption required to attain the subsidy utility level and CV φ is a similar measure quantifying the utility gain under workfare.
s.t . (1 + τc )c + (1 − v)m = (1 − τh )hm + T m ≥ 0,
401
(GBC2)
2.3. Calibration Welfare computations are based on this two sector version of Ragan (2013) calibrated to match time use and consumption data from the U.S. The elasticity of substitution is chosen to match Rogerson (2007), ρ = 0.85. Utility weights α1 = 0.40 and α2 = 0.63, and the share parameter in the production function, a = 0.46, match the U.S. consumption and time use observations in a version of the model where all home sector fiscal policy parameters are set to zero. Tax policy measures are computed following Prescott (2004) and public expenditure policy parameters based on data from the Social Expenditure Database (SOCX, 2001), as reported in Ragan (2013), are presented in Table 1.
Detailed information on the calibration of the model and the data for the computation of the tax and home sector policy parameters can be found in Ragan (2013). 3. Welfare analysis 3.1. Subsidy policies in three economies Given existing taxes on labor and consumption, how should revenues be allocated between lump sum transfers and subsidies of goods which substitute for home work? Consider the optimal subsidy problem where V (·) denotes the indirect utility function of the household,
Λ(ν, T ; τc , τh ) = max V (τc , τh , ν, T ) {ν,T }
+ µ(τh hm + τc c − T − ν m).
(1)
The experiment is to study what happens to welfare as government expenditures are shifted from lump sum transfers to subsidizing home goods while tax rates are fixed. Subsidies are financed through lump sum transfers since tax rates are fixed. Fig. 1 illustrates model predictions for utility in the U.S., France, and Sweden as subsidies to m are increased from ν = 0, the baseline for each economy. Fig. 1 plots the increase in consumption from the baseline (ν = 0) required to achieve the utility level associated with a given subsidy policy. The experiment is done for economies with different tax policies.3 Subsidies in a low tax economy like the U.S. could generate welfare gains equivalent to two percent of baseline consumption as demonstrated by the solid line in Fig. 1. In high tax economies like Sweden, a subsidy policy could generate welfare gains on the order of three percent of consumption, as shown by the dash–dot line. Introducing small subsidies can have relatively large welfare effects in low tax economies. The intuition behind this result can be seen in the envelope condition from the optimal subsidy problem, ∂V = λm|(h∗m ,h∗s ,m∗ ;τc ,τh ,ν,T ) . At ν = 0 the marginal utility of ∂ν income for households in the U.S. is less than for households in SW FR France and Sweden, λUS ν=0 < λν=0 < λν=0 , corresponding to their different levels of market sector consumption. The amount of m consumed in the U.S. is much greater than in France or Sweden, ∂V SW FR mUS ν=0 > mν=0 > mν=0 . Differences in m dominate ∂ν at ν = 0, and ∂ V US ∂ν
>
∂ V FR ∂ν
>
∂ V SW . ∂ν
Hence, small subsidies can generate large welfare gains in low tax economies relative to high tax economies.
3 Preference and production technologies are the same across countries, only policy parameters differ.
402
K.S. Ragan / Economics Letters 118 (2013) 400–403
Fig. 1. Welfare gains from introducing a subsidy policy.
under alternative policy regimes. The policies compared within each country are equivalent in terms of public expenditures as a share of market production, and welfare gains are reported in terms of the compensating variation (CV) in baseline consumption (ν = φ = 0) required to attain the utility level associated with a given home sector policy. Given policy parameters consistent with the aggregate data, Table 1 illustrates how the choice of home sector policy is neither trivial, as no policy is universally preferred, nor negligible in terms of welfare consequences. The final column reports differences in welfare gains across the workfare and subsidy policies, CV φ − CV υ . Negative values imply that at the public expenditure levels and tax rates observed in the data the subsidy policy is preferred, while positive values correspond to the gain from structuring home sector policies as workfare transfers relative to subsidies. Table 1 extends the conclusions drawn from Fig. 2 to a broad set of countries. Subsidy policies are preferred in low tax/low public expenditure economies such as the U.S., Spain, UK, Portugal, and Canada. The welfare gains associated with the workfare and the subsidy policy are equal in Italy. While in high tax/high public expenditure countries workfare policies are preferred, and the welfare gains associated with the design of home sector policy can be large. In the high tax/high public expenditure countries of Scandinavia switching from a subsidy to a workfare policy can increase welfare three fold relative to the gain of introducing a subsidy policy. The design of home sector fiscal policy is an important margin along which policy can influence welfare. 4. Conclusion
Fig. 2. Welfare comparison of subsidy and workfare policies.
3.2. Comparing subsidy and workfare policies The workfare policy can induce households to shift labor out of the home sector and into the market. While subsidy policies can be welfare improving in both low and high tax economies, they are not always preferred to workfare transfers. Fig. 2 plots the increase in baseline consumption (ν = φ = 0) required to achieve the utility level associated with a given home sector policy at different levels of public expenditure as a share of market sector output. The black lines represent the U.S. and the light lines represent Sweden. In the U.S. the subsidy policy (solid black) is preferred to the workfare policy (dash black) up until expenditures on the home sector policy approach four percent of consumption. When home sector fiscal policies are large enough the workfare policy is preferred. In Sweden the workfare policy dominates the subsidy policy at all levels of public expenditure. This illustrates how the tax wedge and the scale of public expenditures interact to determine the preferred design of home sector fiscal policies. 3.3. Home sector policy design in the O.E.C.D. Given tax rates and policy parameters for the 13 O.E.C.D. countries reported in Ragan (2013), Table 1 presents welfare gains
Labor taxes drive a wedge between the marginal product of home work, hs , and market services, m, in the production of home goods, s. In the absence of tax distortions, production efficiency equates the marginal productivity of home sector inputs. Both subsidy and workfare policies can mitigate the inefficiencies in home sector production induced by labor taxes and increase welfare relative to a model with taxes and lump sum transfers alone. The potential welfare gains from the choice of home sector fiscal policy design are sizable, on the order of five percent of consumption in some Scandinavian countries. The choice of policy is not trivial as the relative advantage of each policy depends both on the level of public expenditures as well as the magnitude of market sector taxes. Modeling home sector fiscal policy is important not only in matching market and non-market time use patterns but also for quantifying the potential for welfare improvements through policy design. The design of home sector policy is just as important as the size of public expenditures in terms of their potential welfare effects. Even in low tax/low public expenditure countries such as the U.S., designing home sector policies as subsidies, versus workfare transfers, can double the potential welfare gains associated with a given level of expenditure. These potential gains are magnified in high tax/high public expenditure economies such as Scandinavia, where workfare policies imply a two to three fold increase in welfare relative to similarly costly subsidy policies. Given policy parameters consistent with the data only Italy is indifferent to the design of home sector expenditures. In the rest of the O.E.C.D., the welfare gains associated with the design of home sector policies are significant both in relative and absolute terms. Acknowledgment This work was supported by the Bank of Sweden Jubileum’s Fund [grant P2007-0468:1-E]. References Ngai, Rachel, Pissarides, Christopher, 2011. Taxes, social subsidies and the allocation of work time. American Economic Journal: Macroeconomics 3 (4), 1–26. American Economic Association. O.E.C.D.,2001. Social Expenditures Database.
K.S. Ragan / Economics Letters 118 (2013) 400–403 Prescott, Edward C., 2004. Why do Americans work so much more than Europeans? Federal Reserve Bank of Minneapolis Quarterly Review 28 (1), 2–13. Rogerson, Richard., 2007. Taxation and market work: is scandinavia an outlier? Economic Theory 32, 59–85. Ragan, Kelly., 2013. Taxes, transfers and time use: fiscal policy in a household production model. American Economic Journal: Macroeconomics 5 (1), 1–28.
403
Rosen, Sherwin., 1996. Public employment and the welfare state in Sweden. Journal of Economic Literature 34 (2), 729–740. Rosen, Sherwin., 1997. Public employment, taxes, and the welfare state in Sweden. In: Freeman, R.B., Topel, R., Swedenborg., B. (Eds.), The Welfare State in Transition. University of Chicago Press, Chicago.
Contents lists available at SciVerse ScienceDirect
Economics Letters journal homepage: www.elsevier.com/locate/ecolet
Quantitative evidence on the welfare effects of home sector fiscal policy Kelly S. Ragan ∗ Stockholm School of Economics, Box 6501, 113 83 Stockholm, Sweden
article
info
Article history: Received 12 October 2012 Received in revised form 21 November 2012 Accepted 24 November 2012 Available online 12 December 2012
abstract A home production model that explicitly accounts for taxes and public expenditures on day-care and elder-care, substitutes for work households perform at home, is used to evaluate the welfare implications of alternative public expenditure policies. Both subsidy and workfare policies are welfare improving relative to a model where tax revenues are rebated lump sum. The welfare gains from optimal home sector policy design can be large. © 2012 Elsevier B.V. All rights reserved.
JEL classification: J22 E26 E62 Keywords: Home production Public expenditures Subsidy Workfare
1. Introduction Transfers of goods such as day-care and elder-care account for a sizable share of public expenditure in the O.E.C.D. Although important for matching labor supply patterns, the welfare implications of policies which subsidize or transfer market goods which substitute for time spent working at home are not well understood.1 I extend the analysis of the welfare consequences of public expenditure policies presented in Rosen (1996, 1997) to a general equilibrium setting and analyze policies from a broad set of countries. I investigate how the design of public expenditures and the magnitude of market sector taxes interact to affect welfare in a two-sector home production model. The policies modeled emphasize both the subsidy and workfare features of public expenditures discussed by Rosen (1996, 1997). Neither policy design is universally preferred. Instead, preferred home sector fiscal policies are shown to depend on the size of market sector tax distortions as well as the scale of public expenditures. In general, countries with low tax rates and low levels of public expenditure prefer subsidy policies, while countries with large market sector tax distortions and high public expenditure on home
∗
goods find it optimal to structure public expenditures as workfare transfers. Even holding constant tax and public expenditure levels, the scope for welfare improvement in the design of home sector fiscal policies is large. 2. Model Utility is an additively separable log utility specification defined over market goods, c, home services, s, and leisure, 1 − hm − hs , U (c , s, 1 − hm − hs ) = (1 − α1 )α2 log c + (1 − α1 )(1 − α2 ) log s
+ α1 log(1 − hm − hs ). There are two productive sectors, the market and the home sector. The household allocates labor to both. The household’s problem is to maximize utility subject to the budget constraint, the home production technology, and additional feasibility constraints on labor allocations (hm ≥ 0, hs ≥ 0, h = hm + hs ≤ 1). Market production is linear in labor, y = hm , and this output can be consumed directly, c, or used as an input into home services production, m.2 The aggregate feasibility constraint equates output to the sum of its uses, y = m + c. Home goods, s, are produced using household labor, hs , and market inputs, m. The government
Tel.: +46 76 3370703. E-mail address: [email protected].
1 See Ragan (2013), Ngai and Pissarides (2011), and Rogerson (2007) for quantitative evidence on the role of public expenditures in driving labor supply allocations in the O.E.C.D. 0165-1765/$ – see front matter © 2012 Elsevier B.V. All rights reserved. doi:10.1016/j.econlet.2012.11.030
2 Output is freely divisible. I do not specify alternative production functions for c and m, nor allow for sectoral productivity differences. In this regard market sector taxes, not productivity differences, lead to differences in the composition of output.
K.S. Ragan / Economics Letters 118 (2013) 400–403
raises revenues from market sector taxes on consumption and labor {τc , τh }, and whatever revenues are not spent on home sector policies are rebated to households in the form of a lump sum transfer denoted by T . Lump sum taxation is not allowed, T ≥ 0. The household’s problem is discussed under two alternative policy regimes. 2.1. Subsidy policy Subsidies of goods like day-care and elder-care, market goods which substitute for households’ own time in the production of home services, are captured by the subsidy ν . Given the policy quadruplet (τc , τh , ν, T ) the household solves the following problem: max
hm ,hs ,c ,m
U (c , s, 1 − h)
s = [amρ + (1 − a)hρs ]1/ρ hm ≥ 0 ,
hs ≥ 0,
h = hm + hs ≤ 1. Subsidies enter the household’s decision problem through the budget constraint as the price of a unit of m is only 1 − v . The government’s budget constraint equates expenditures in the form of lump sum transfers, T , and subsidies of market inputs to home production, v × m, to revenues from taxes on market sector labor and consumption: T + v m = τh hm + τc c .
(GBC1)
2.2. Workfare policy Rosen (1996) emphasized how benefits such as publicly provided day-care were closely tied to employment. To capture this link, public expenditures are modeled as transfers that are proportional to market work, φ hm , where φ denotes the transfer rate. Public transfers, φ hm , are a perfect substitute for m in the production of home services. Given the policy quadruplet (τc , τh , φ, T ) the household solves the following problem: max
hm ,hs ,c ,m
U (c , s, 1 − h)
s.t . (1 + τc )c + m = (1 − τh )hm + T s = [a (φ hm + m)ρ + (1 − a)hρs ]1/ρ m ≥ 0,
hm ≥ 0 ,
hs ≥ 0,
h = hm + hs ≤ 1. The workfare policy alters all three of the household’s first order conditions. With respect to the market work decision, there are now additional home sector returns to allocating labor to the market. The government budget constraint also includes in-kind transfers to households that are proportional to market work, T = (τh − φ)hm + τc c .
Table 1 Welfare comparison of expenditure equivalent policies.
US Spain UK Portugal Canada Italy France Belgium Germany Finland Sweden Norway Denmark
1+τc 1−τh
Subsidy
υ
CV
1.67 1.77 1.80 1.81 2.04 2.30 2.51 2.53 2.55 2.77 3.20 3.66 4.28
0.16 0.20 0.22 0.15 0.17 0.25 0.38 0.36 0.33 0.43 0.54 0.58 0.60
0.71 0.89 1.07 0.69 0.66 0.82 1.42 1.08 0.97 1.60 2.01 1.86 1.69
CV φ − CV ν
Workfare ν
φ
φ
CV
0.01 0.02 0.03 0.01 0.01 0.01 0.04 0.02 0.02 0.05 0.11 0.10 0.10
0.34 0.57 0.93 0.43 0.39 0.82 2.59 1.63 1.42 3.52 6.75 6.93 7.34
−0.37 −0.32 −0.14 −0.27 −0.26 0.00 1.17 0.55 0.45 1.92 4.74 5.07 5.65
Note: see Ragan (2013) for computation of the policy parameters and sources. CV ν is the percent increase in baseline consumption required to attain the subsidy utility level and CV φ is a similar measure quantifying the utility gain under workfare.
s.t . (1 + τc )c + (1 − v)m = (1 − τh )hm + T m ≥ 0,
401
(GBC2)
2.3. Calibration Welfare computations are based on this two sector version of Ragan (2013) calibrated to match time use and consumption data from the U.S. The elasticity of substitution is chosen to match Rogerson (2007), ρ = 0.85. Utility weights α1 = 0.40 and α2 = 0.63, and the share parameter in the production function, a = 0.46, match the U.S. consumption and time use observations in a version of the model where all home sector fiscal policy parameters are set to zero. Tax policy measures are computed following Prescott (2004) and public expenditure policy parameters based on data from the Social Expenditure Database (SOCX, 2001), as reported in Ragan (2013), are presented in Table 1.
Detailed information on the calibration of the model and the data for the computation of the tax and home sector policy parameters can be found in Ragan (2013). 3. Welfare analysis 3.1. Subsidy policies in three economies Given existing taxes on labor and consumption, how should revenues be allocated between lump sum transfers and subsidies of goods which substitute for home work? Consider the optimal subsidy problem where V (·) denotes the indirect utility function of the household,
Λ(ν, T ; τc , τh ) = max V (τc , τh , ν, T ) {ν,T }
+ µ(τh hm + τc c − T − ν m).
(1)
The experiment is to study what happens to welfare as government expenditures are shifted from lump sum transfers to subsidizing home goods while tax rates are fixed. Subsidies are financed through lump sum transfers since tax rates are fixed. Fig. 1 illustrates model predictions for utility in the U.S., France, and Sweden as subsidies to m are increased from ν = 0, the baseline for each economy. Fig. 1 plots the increase in consumption from the baseline (ν = 0) required to achieve the utility level associated with a given subsidy policy. The experiment is done for economies with different tax policies.3 Subsidies in a low tax economy like the U.S. could generate welfare gains equivalent to two percent of baseline consumption as demonstrated by the solid line in Fig. 1. In high tax economies like Sweden, a subsidy policy could generate welfare gains on the order of three percent of consumption, as shown by the dash–dot line. Introducing small subsidies can have relatively large welfare effects in low tax economies. The intuition behind this result can be seen in the envelope condition from the optimal subsidy problem, ∂V = λm|(h∗m ,h∗s ,m∗ ;τc ,τh ,ν,T ) . At ν = 0 the marginal utility of ∂ν income for households in the U.S. is less than for households in SW FR France and Sweden, λUS ν=0 < λν=0 < λν=0 , corresponding to their different levels of market sector consumption. The amount of m consumed in the U.S. is much greater than in France or Sweden, ∂V SW FR mUS ν=0 > mν=0 > mν=0 . Differences in m dominate ∂ν at ν = 0, and ∂ V US ∂ν
>
∂ V FR ∂ν
>
∂ V SW . ∂ν
Hence, small subsidies can generate large welfare gains in low tax economies relative to high tax economies.
3 Preference and production technologies are the same across countries, only policy parameters differ.
402
K.S. Ragan / Economics Letters 118 (2013) 400–403
Fig. 1. Welfare gains from introducing a subsidy policy.
under alternative policy regimes. The policies compared within each country are equivalent in terms of public expenditures as a share of market production, and welfare gains are reported in terms of the compensating variation (CV) in baseline consumption (ν = φ = 0) required to attain the utility level associated with a given home sector policy. Given policy parameters consistent with the aggregate data, Table 1 illustrates how the choice of home sector policy is neither trivial, as no policy is universally preferred, nor negligible in terms of welfare consequences. The final column reports differences in welfare gains across the workfare and subsidy policies, CV φ − CV υ . Negative values imply that at the public expenditure levels and tax rates observed in the data the subsidy policy is preferred, while positive values correspond to the gain from structuring home sector policies as workfare transfers relative to subsidies. Table 1 extends the conclusions drawn from Fig. 2 to a broad set of countries. Subsidy policies are preferred in low tax/low public expenditure economies such as the U.S., Spain, UK, Portugal, and Canada. The welfare gains associated with the workfare and the subsidy policy are equal in Italy. While in high tax/high public expenditure countries workfare policies are preferred, and the welfare gains associated with the design of home sector policy can be large. In the high tax/high public expenditure countries of Scandinavia switching from a subsidy to a workfare policy can increase welfare three fold relative to the gain of introducing a subsidy policy. The design of home sector fiscal policy is an important margin along which policy can influence welfare. 4. Conclusion
Fig. 2. Welfare comparison of subsidy and workfare policies.
3.2. Comparing subsidy and workfare policies The workfare policy can induce households to shift labor out of the home sector and into the market. While subsidy policies can be welfare improving in both low and high tax economies, they are not always preferred to workfare transfers. Fig. 2 plots the increase in baseline consumption (ν = φ = 0) required to achieve the utility level associated with a given home sector policy at different levels of public expenditure as a share of market sector output. The black lines represent the U.S. and the light lines represent Sweden. In the U.S. the subsidy policy (solid black) is preferred to the workfare policy (dash black) up until expenditures on the home sector policy approach four percent of consumption. When home sector fiscal policies are large enough the workfare policy is preferred. In Sweden the workfare policy dominates the subsidy policy at all levels of public expenditure. This illustrates how the tax wedge and the scale of public expenditures interact to determine the preferred design of home sector fiscal policies. 3.3. Home sector policy design in the O.E.C.D. Given tax rates and policy parameters for the 13 O.E.C.D. countries reported in Ragan (2013), Table 1 presents welfare gains
Labor taxes drive a wedge between the marginal product of home work, hs , and market services, m, in the production of home goods, s. In the absence of tax distortions, production efficiency equates the marginal productivity of home sector inputs. Both subsidy and workfare policies can mitigate the inefficiencies in home sector production induced by labor taxes and increase welfare relative to a model with taxes and lump sum transfers alone. The potential welfare gains from the choice of home sector fiscal policy design are sizable, on the order of five percent of consumption in some Scandinavian countries. The choice of policy is not trivial as the relative advantage of each policy depends both on the level of public expenditures as well as the magnitude of market sector taxes. Modeling home sector fiscal policy is important not only in matching market and non-market time use patterns but also for quantifying the potential for welfare improvements through policy design. The design of home sector policy is just as important as the size of public expenditures in terms of their potential welfare effects. Even in low tax/low public expenditure countries such as the U.S., designing home sector policies as subsidies, versus workfare transfers, can double the potential welfare gains associated with a given level of expenditure. These potential gains are magnified in high tax/high public expenditure economies such as Scandinavia, where workfare policies imply a two to three fold increase in welfare relative to similarly costly subsidy policies. Given policy parameters consistent with the data only Italy is indifferent to the design of home sector expenditures. In the rest of the O.E.C.D., the welfare gains associated with the design of home sector policies are significant both in relative and absolute terms. Acknowledgment This work was supported by the Bank of Sweden Jubileum’s Fund [grant P2007-0468:1-E]. References Ngai, Rachel, Pissarides, Christopher, 2011. Taxes, social subsidies and the allocation of work time. American Economic Journal: Macroeconomics 3 (4), 1–26. American Economic Association. O.E.C.D.,2001. Social Expenditures Database.
K.S. Ragan / Economics Letters 118 (2013) 400–403 Prescott, Edward C., 2004. Why do Americans work so much more than Europeans? Federal Reserve Bank of Minneapolis Quarterly Review 28 (1), 2–13. Rogerson, Richard., 2007. Taxation and market work: is scandinavia an outlier? Economic Theory 32, 59–85. Ragan, Kelly., 2013. Taxes, transfers and time use: fiscal policy in a household production model. American Economic Journal: Macroeconomics 5 (1), 1–28.
403
Rosen, Sherwin., 1996. Public employment and the welfare state in Sweden. Journal of Economic Literature 34 (2), 729–740. Rosen, Sherwin., 1997. Public employment, taxes, and the welfare state in Sweden. In: Freeman, R.B., Topel, R., Swedenborg., B. (Eds.), The Welfare State in Transition. University of Chicago Press, Chicago.