Taxes, Transfers and Time Use: Fiscal Policy in
a Household Production Model
Kelly Ragan
Stockholm School of Economics
September 15, 2006
Abstract
I develop a household production model where the public provision of
home goods plays a prominent role. This model accurately …ts time use
in the market and home sectors for a broad group of O.E.C.D. countries
in terms of both tax policy and public expenditures. Taxes alone cannot explain market and home sector labor supply patterns in the O.E.C.D.
Accounting for the structure of public expenditures, in particular the public provision of home goods, is important for model predictions and welfare
analysis. The model and data I present show that adopting …scal policies
similar to the U.S. would lead to welfare gains equivalent to ten percent of market and home goods consumption in some European countries.
I compute optimal policy rules under alternative assumptions regarding
how public revenues are generated. The gains to optimal home sector …scal policy design are of similar magnitudes to the welfare gains associated
adopting a tax system similar to the U.S. for some high tax/high public
expenditure countries.
1
Introduction
Publicly provided goods that are close substitutes for home produced goods
are as important as taxes in explaining labor supply patterns in the O.E.C.D.
Households’decisions about working in the market versus spending time in nonmarket activities such as leisure and home production are in‡uenced both by
taxes and public expenditures. This paper explicitly models how households
allocate their time outside the market and quanti…es the extent of home work
and leisure in the O.E.C.D. The empirical evidence presented in this paper
suggests that home production is an important margin along which households
respond to market sector price distortions.
I would like to thank Nancy Stokey, Robert Lucas, Casey Mulligan, Erik Hurst, Steve
Davis and Robert Shimer. Contact information: [email protected] or Stockholm School
of Economics, Department of Economics, P.O. Box 6501, SE-11383 Stockholm, Sweden.
1
Prescott (2002, 2004) and Davis and Henrekson (2004) argue that taxes can
explain di¤erences in market work and consumption patterns in the O.E.C.D.1
The household production model developed in chapter two illustrates how taxes
alone cannot generate labor supply patterns consistent with the data. This
baseline model suggests that Scandinavians should be working in the market
sector 20 to 45 percent less than observed, and 15 to 30 percent more in the
home sector.
Accounting for public expenditures on home goods is important for explaining labor supply in the market and at home. Public expenditures on day care
and elder care are of similar magnitudes to expenditures on unemployment insurance in France, the U.S., and elsewhere. These expenditures are prominent
features of O.E.C.D. welfare states, yet there exists little systematic analysis of
how such expenditures a¤ect labor market outcomes. To motivate modelling
public expenditures in detail, in particular transfers of home goods like day care,
chapter three presents empirical evidence that public expenditures on goods like
day care are economically and statistically signi…cant determinants of employment in the O.E.C.D. Relaxing the simplifying assumption made by Prescott
(2002, 2004) regarding how public resources are transferred to households and
modelling home sector …scal policies explicitly makes a big di¤erence both with
respect to labor supply predictions and the implied welfare consequences of
existing …scal policies.
High marginal tax rates discourage market activity and individuals shift
production into the non-taxed home sector. This is especially true when one’s
own labor is a good substitute for hired labor, as in the case of child care. The
tax distortion can be partially o¤set by subsidies on market goods, such as day
care, that are close substitutes for home goods. Extensive subsidies to market
substitutes for some home goods, in particular child and elder care, are salient
features of …scal policy in many O.E.C.D. countries. Chapter four augments
the home production model to formalize the home sector …scal policies described
by Rosen (1996).
The home production model I examine explicitly accounts for public expenditures on home goods. This model can match market and home sector labor
supply patterns for a broad range of countries. The model permits a more
systematic treatment of the welfare e¤ects of …scal policies in the O.E.C.D.
Chapter …ve presents a welfare analysis and discussion of optimal …scal policies
under alternative assumptions regarding how the public sector raises revenues.
Chapter six concludes.
1 Although
home sector labor supply is not explicitly modeled in either of these papers, in
explaining the variations of market sector labor supply and consumption the authors suggest
that di¤erences in consumption and labor supply in the unmeasured home sector are also
large. Freeman and Schettkat (2005) provide evidence of this for the case of Germany.
2
2
Household Production Model
Households in the O.E.C.D. spend, on average, 49% of their available time
working.2 Most of this work occurs in the home sector (26%) while somewhat
less takes place in the market (23%). Time use relative to the U.S. is plotted
in …gure 1 for a group of ten O.E.C.D. countries. Figure 1 shows how total
work varies much less than its components across countries. The data suggests
that the relevant question is not why do Europeans work so little, or conversely
why do they enjoy so much leisure, but why do they choose to work so much
at home? A two sector model, where households choose to work in the market
or tax favored home sector allows us to analyze how taxes in‡uence household
production decisions. This baseline model will be extended to incorporate home
sector …scal policies in chapter 4.
2.1
The Model
There are two productive sectors, the market and the home sector. The household allocates labor to both. The market sector production technology transforms labor 1:1 into output. This output can be consumed directly, c, or used
as an input into home production, m. Household services, s, are produced
using household labor, hs , and market inputs, m. Household utility is de…ned
over market consumption (c), household services (s), and leisure (1 hm hs ).
The government taxes market labor income and market sector consumption at
proportional rates.3 The proceeds of these taxes are rebated to the household
in the form of a lump sum transfer, T = h hm + c c.
The instantaneous utility function is a version of the utility speci…cation
described by Browning, Hansen and Heckman (1999). The household faces the
following utility maximization problem:
max U (c; s; 1 h) = max ac log(c) + as log(s) + (1 ac as ) log(1 h)
s:t: (1 + c )c + m = (1
(BC1)
h )hm + T
1=
s = [am + (1 a)hs ]
(HHP1)
hm
0; hs 0; h = hm + hs 1; m 0:
Utility is additively separable in market consumption, home goods and leisure.
The production technology for this economy transforms market work into a
general good that can be consumed as consumption, c, or used as a input to home
production, m. The aggregate production function is linear in labor, y = hm :
The feasibility constraint equates output to the sum of its uses, y = m + c. The
2 See
table 11 for more detail on home sector time use.
have assumed here that m is not subject to the consumption tax. Services are typically
taxed less than goods consumption in the countries considered here. In particular, day care
is not taxed in many of the countries studied here such as Sweden. Incorporating taxes on
market procured home services would alter the optimality conditions presented here.
3I
3
government budget constraint equates tax revenue to the lump sum transfer, T .
Lump sum taxation is not allowed so T is restricted to be non-negative.
cc
+
h hm
= T:
(GBC1)
The optimality conditions for an interior solution are:
@L
@hm
@L
@hs
@L
@m
=
=
=
ac (1
1 ac as
h)
=0
(1
m+T
1 hm hs
h )hm
as (1 a)hs 1
1 ac as
=0
[am + (1 a)hs ] 1 hm hs
ac
as am 1
+
= 0:
(1
m+T
[am + (1 a)hs ]
h )hm
(1)
(2)
(3)
The optimality conditions from the household production model imply that market labor is chosen to equalize the tax adjusted marginal utility gain of market
consumption with the marginal utility of leisure. The home work choice equates
the gain from working in the home sector, the product of the marginal utility of
home goods consumption and the marginal product of home work, to the marginal utility of leisure. The consumption decision is determined by equating
the marginal utility gain from buying market inputs to home production to the
marginal utility of market goods consumption.
These three conditions, when combined with the tax rate measures f h ; c g
and preference and technology parameters (as ; ac ; a) calibrated from U.S. data
generate labor supply patterns that match those observed in the data for most
countries. The notable exceptions are the Scandinavian countries. This model
understates market work by 20 to 45 percent in the high tax wedge Scandinavian
countries and overstates home work by 15 to 30 percent relative to actual levels.
The household production model predicts that market work should be declining in the tax wedge, and quite dramatically at high tax rates. This …ts with
observed patterns of labor supply in the U.S., Canada, the U.K., and Europe,
but not Scandinavia as seen in table 1 and …gure 2. The model also suggests
that home work should be increasing in the tax wedge, a trend supported in the
data with the notable exception of the high tax wedge Scandinavian countries,
as illustrated in …gure 3. The equilibrium outcomes for market work, home
work and leisure reported in table 1 and …gures 2-4 satisfy the household’s optimality conditions and the government’s budget constraint. These results are
robust to alternative measures of home work as well as for alternative choices
of .
The baseline household production model is successful in matching labor and
leisure patterns for Canada, Europe and the U.S. Yet, it cannot reconcile the
high levels of market work and low levels of home work observed in Scandinavia.
Large tax wedges in Scandinavia result in low predicted market work levels.
This runs counter to what we observe in the data, namely that Scandinavians
work more in the market sector than their lesser taxed European counterparts.
The baseline model also predicts that Scandinavians should work more at home
4
than households in the U.S. and Europe, when in fact Scandinavians work at
home in levels comparable to the U.S., and less than other Europeans. Chapter
4 reconciles the predictions of the home production model with the data by
explicitly modelling public expenditures on goods that are close substitutes for
home production.
2.2
Model Properties and Calibration
The important most parameter with respect to this analysis is . It determines
the elasticity of substitution between time and market goods such as day-care
in the household production function.4 Aguiar and Hurst (2005) use detailed
data on time spent shopping and expenditures on food to estimate an elasticity
of substitution between time and goods in the household production function.
Their estimated elasticity of total home production time and expenditures suggests a value of = 0:6. This suggests a high degree of substitutability between
household time and expenditures on goods like food.
For the case of services like day care, the substitutability of time and goods
in the home production function may be even greater than Aguiar and Hurst
(2005) suggest. Day care consumption has a large e¤ect on time spent working
in the household sector. Hallberg and Klevmarken (2001) …nd that while direct
time spent with children responds relatively little to whether a child is in day
care, the amount of time spent on other household chores responds much more.
This result is echoed in Gustafsson and Kjulin (1994). They …nd that for
younger children (0-2 yrs.) total time dedicated to housework decreases by 4.7
hours per week if a child is cared for outside the home, and for older children
the reduction in housework associated with having a child in day care is 6 hours
a week. These are large responses given that the average Swede is spending
twenty-…ve hours a week performing household work. These empirical studies
lend weight to the assertion that home work is elastic with respect to market
inputs in the form of child care services.5
To re‡ect the empirical evidence that home work is highly responsive to the
consumption of market goods like day care the results reported here assume
= 0:9. Results for alternative values of are qualitatively and quantitatively similar. For either choice of the baseline home production model does
well explaining aggregate patterns of market work, home work and leisure of
households in the U.S., Canada and Europe with the notable exception of the
4 McGrattan, Rogerson and Wright (1996) estimate a household production function using
U.S. time series data. Their measure of market inputs to the household production function
is an imputed stock of household capital goods de…ned as residential housing and the stock
of household durables. Using this measure of market inputs to household production they
cannot reject that the elasticity of substitution is 1 and that the production function is CobbDouglas, but their point estimate of is more than a standard deviation above zero. This
estimated elasticity is likely too low for goods like day care.
5 In the context of a cross-country comparison such as this, where di¤erences in transfer
systems have existed for decades, large elasticities may also re‡ect the longer horizons over
which behavioral responses to …scal policies have evolved.
5
Scandinavians.
Baseline model parameters are calibrated to …t data from the U.S. for given
values of . This requires measures of U.S. tax rates, labor supply, and the
m
).6 Given
share of consumption that takes the form of personal services ( m+c
these data observations and choices for the share parameters in the utility
function and home production function are determined. The data used in the
calibration exercise and the calibrated parameters for several choices of are
detailed in table 2.
Recent work has taken a di¤erent approach to explaining cross-country labor
supply variations. Alesina, Glaeser and Sacerdote (2005), hereafter AGS, suggest that the low levels of market work in Europe are the result of institutions
like unions and labor market regulations that enforce a low work/high leisure
equilibrium where a social multiplier makes leisure more advantageous when
aggregate leisure consumption increases. This explanation runs counter to the
data presented here which suggests that leisure varies less than market work in
the O.E.C.D. The AGS model provides little insight into the home work patterns observed here and why they diverge so dramatically for the Scandinavian
countries. Davis and Henrekson (2004) analyze the e¤ect of the tax wedge on
industry mix across several rich countries. They do not consider the child and
elder care sectors highlighted in this paper. Others, such as Olovsson (2004),
have considered the importance of marginal income tax rates on labor supply
in a model with household production. While Olovsson claims his model can
explain di¤erences in Swedish labor supply relative to the U.S. his model cannot explain the very low levels of labor supply observed in European countries
where tax wedges are smaller than in Scandinavia. Olovsson’s model relies on a
wage dispersion policy parameter to drive his results. This source of variation
in …scal policy is more di¢ cult to motivate than the measured di¤erences in
public expenditures on goods like day care and elderly care used in this model.
3
Fiscal Policy and Employment
Explanations for why per capita measures of labor supply vary so markedly
among countries with arguably similar production technologies and preferences
have focused on di¤erences in …scal policies and transfer systems. Transfers
conditioned on non-employment have been the focus of much of the literature.
Models such as those described by Ljungqvist and Sargent (1998) have emphasized the role of aggregate shocks and unemployment insurance.7 In contrast
6 In the context of this model m should measure the consumption of market services like day
care and elderly care that are close substitutes for household provided services. Market inputs
to home production are imputed using the consumption of personal care services reported in
the UN National Accounts. These values range from 1.2 percent of net of tax consumption
in Denmark to 2.5 percent in the U.S.. For the U.S. this measure is fairly close to the value
of production in the daycare and eldercare sector.
7 Unemployment insurance is one of many transfer systems that has been described as
contributing to the decline of aggregate employment measures in O.E.C.D. countries. The
cross-country social security study of Gruber and Wise suggests this bene…ts system also
6
to this focus on welfare state institutions and the impact of their design on incentives to work, Prescott (2002, 2004) argues that taxes explain the variation
in market sector labor supply among the G-7.
Publicly provided home goods such as day care and elder care, are important
features of welfare states in the O.E.C.D., yet they have not been considered in
previous labor market studies. A cross-country panel regression provides evidence that the public provision of home goods, like day care, are indeed important determinants of aggregate labor supply.8 These results provide empirical
support that the welfare state institutions modeled here are indeed signi…cant
determinants of aggregate labor supply even after allowing for …xed e¤ects to
capture di¤erences in preferences or institutions across countries.
Public expenditures as a share of consumption are used to proxy for the
availability and generosity of welfare state programs across countries and dates.9
Country speci…c …xed e¤ects capture di¤erences in preferences or institutions
across countries that are constant over time. Year e¤ects capture common aggregate shocks. Equation (4) describes the panel regression of employment rates
(ERi;t ) on country and time …xed e¤ects and welfare state policy measures.
ERi;t = ci + dt +
K
X
k
bk Xi;t
+ vi;t
(4)
k=1
The tax wedge, 11+ hc , the ratio of marginal consumption and labor taxes is included in X to capture the e¤ect of taxes on employment. A measure of union
density is also included. Robust standard errors correct for heteroskedasticity
and serial correlation among error terms. The regression results reported in
table 3 allow us to quantify the aggregate importance of di¤erent public expenditures in explaining variations in employment rates (ER) across O.E.C.D.
countries.
The public provision of goods like day care is an economically and statistically signi…cant factor in explaining employment rates, as table 3 demonstrates.
contributes to reducing employment among some groups. Disability insurance and a list of
other policies contribute to di¤erences in labor market outcomes among O.E.C.D. countries.
8 The data consists of an eighteen year long panel (1980-1997) of employment rates and
expenditure data for sixteen O.E.C.D. countries. The employment to population ratios of
those aged 15-64 are from the O.E.C.D. labor indicators database. Controls included in
the regression are quantitative measures of market sector tax distortions, public expenditures
on cash and in-kind transfers, and degree of unionization. These results are robust to alternative speci…cations and policy measures. For example, extending the empirical method
outlined by Blanchard and Wolfers (2000) with time varying institutions yields similar results.
9 Welfare state institutions are allowed to change over time, in keeping with Lindbeck
(1995) and Rosen (1996) who detail the dramatic growth of the welfare state in recent decades.
Details of welfare state programs vary from country to country in a myriad of ways. Measures
of public expenditures as a share of consumption are meant to proxy for the policy parameters
that enter the representative households labor supply decision. Whether expenditures changes
for a given income transfer are driven by di¤erences in bene…t replacement rates or changes in
eligibility rules is beyond the scope of this exercise. Detailed measures of program eligibility
requirements and bene…t replacement rates cannot be computed from the aggregate data used
here.
7
The marginal e¤ect of public day care expenditures on employment rates is positive and large relative to the marginal e¤ects of other welfare state institutions.
The large positive coe¢ cient on day care expenditures suggests that home sector …scal policies that subsidize market provision of home goods may have large
e¤ects on market sector labor supply. Increasing the expenditure share on the
public provision of day care from the average by 2 percentage points would increase the employment rate by six points.10 The next chapter explicitly models
the mechanisms by which public expenditures on goods like day care lead to
large increases in market sector labor supply.
4
Fiscal Policy and the Home Sector
The quantitative model presented here allows for a second channel for …scal policy to in‡uence household labor supply decisions through the public provision
of home goods such as day care. The models presented here capture two key
features of home sector …scal policies described by Rosen (1996). I present equilibrium outcomes under alternative …scal policies that tax market labor while
subsidizing or transferring market purchase of home goods. Under subsidy rates
consistent with aggregate expenditure data this model accurately predicts both
home and market sector labor supply for a broad range of O.E.C.D. countries.
Modelling home sector …scal policies can reconcile the household production
model’s predictions with aggregate data on labor supply in the market and at
home. The models presented in this chapter build closely on Rosen (1996) who
described how public consumption of goods like day care and elderly care are
substitutes for goods produced in the home sector. Two policies described in
Rosen’s analysis of the welfare state in Sweden are modeled. The …rst subsidizes
the price of market sector home services. The second is a ’workfare’policy that
transfers publicly provided home goods to households in proportion to their
market labor supply. Elements of both of these policies are present to greater
or lesser extent in all of the countries considered here. These policies have
similar implications for aggregate labor supply but di¤erent consequences for
welfare.
The extent of home work has a signi…cant impact on market work decisions.11
Rosen (1996) described how Swedes have substituted publicly produced services
for privately produced home goods. By 1993 almost half a million children
received some kind of subsidized day care (over and above publicly provided
1 0 The variables in X are demeaned. For the case of day care, public expenditures shares
range from zero to three and a half percent of consumption, with average expenditure share
of approximately three quarters of a percent.
1 1 Summary results from the European Community Household Panel (ECHP) survey suggest
that child and elder care make disproportionate demands on women’s time, and also their
decisions to work in the labor market. In Europe, one in three women provide unpaid daily
care for children or adults. According to ECHP respondents, 27% of female and 4% of male
care givers said that informal care activities prevented them from undertaking the amount of
paid work they would otherwise do. These results buttress the aggregate time use statistics
presented earlier.
8
education). This translates into one subsidized day care space per every 10
people in the Swedish population aged 25-64. The size of public expenditures
on home goods such as day care and elderly care are detailed in table 4. Scandinavians allocate ten to twenty times more of their consumption to publicly
provided home goods than the U.S. These are large policy di¤erences that can
have a large e¤ect on the labor supply predictions of the household production
model.
Fiscal policies exist in all of these countries to provide subsidies to market
procured home services. The availability of subsidized home services, in particular day care, is frequently linked to market labor supply. Though the details
of home sector …scal policies vary across countries these two common features
are captured in the models presented here. The following sections extend the
household production model by incorporating a richer set of …scal policies that
capture these features of the welfare state.
4.1
Home Production with Subsidies
In addition to taxes and lump sum transfers, the government can a¤ect the
price of market inputs to household production through a subsidy, . Given
the policy quadruplet ( c ; h ; ; T ) the household solves the following problem:
max U (c; s; 1 h) = max ac log(c) + as log(s) + (1 ac as ) log(1 h)
s:t: (1 + c )c + (1 v)m = (1
(BC2)
h )hm + T
1=
s = [am + (1 a)hs ]
(HHP2)
m
0; hm 0; hs 0; h = hm + hs 1:
The production technology and feasibility constraint are the same as in the
baseline model. The market good m is a substitute for household time in the
household services production function (HHP2). Subsidies enter the household’s
decision problem through the budget constraint (BC2). 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 labor supply and consumption:
T + vm =
h hm
+
c c:
(GBC2)
The …rst order conditions for the household’s problem are similar to those
in the baseline model. The …rst order condition with respect to market work is
adjusted to account for the subsidy in the denominator of the …rst term. This is
an income e¤ect for the household. For any amount of m chosen the household
can now a¤ord more consumption. The …rst order condition with respect to
home work is unchanged while the conditions that determines the choice of
market inputs to home production is altered to incorporate both income and
9
price e¤ects.
@L
@hm
@L
@hs
@L
@m
=
=
=
ac (1
1
h)
(1
)hm (1 v)m + T
1
1 ac as
as (1 a)hs 1
am + (1 a)hs
1 hm hs
ac (1 v)
+
(1
)h
(1 v)m + T
h m
ac
hm
as
=0
hs
(5)
=0
as am
am + (1
(6)
1
a)hs
=0
(7)
m
, to
Matching public expenditure shares on home services in the model, vc+m
those observed in the data we can solve for the implied subsidy rate, v.
Accounting for home sector …scal policies can have a large e¤ects on model
predictions, in particular for the high tax wedge/high public expenditure Scandinavian countries. Including subsidies closes the entire gap between predicted
and actual market work for Norway, half the gap for Sweden and Finland, and
less for Denmark, as shown in …gure 5 (light diamonds denote baseline predictions for the Scandinavian outliers, while dark diamonds to the right denote
the subsidy model predictions for market work). Home sector subsidies can
close the entire gap between predicted and actual home work for Sweden and
Norway, more than half of the gap for Finland, and almost half of the gap for
Denmark, as shown in …gure 6 (light diamonds denote baseline predictions for
the Scandinavian outliers, while dark diamonds to the left denote the subsidy
model predictions for home work). The subsidy policy increases the predicted
levels of leisure for Scandinavian households by a small amount as shown in
…gure 7. Table 5 outlines these results in detail and shows how accounting for
home sector policies can improve model …t in both the market work and home
work dimensions.
In all of the Scandinavian countries the subsidy rates implied by the aggregate data are in regions where small increases in subsidy rates would generate
market sector labor supply consistent with the aggregate data. In this model
the marginal subsidy rate is equal to the average subsidy rate. In reality, the
more child care or elder care the household consumes the higher their marginal subsidy rate. The fees charged for the second child in day care are less
than for the …rst child, and fee caps imply that the price of additional day care
consumption falls to zero for some households. Allowing for a small amount of
progressivity in subsidy rates could generate market labor supply equal to levels
observed in the high tax wedge Scandinavian countries. A sensitivity analysis
of Swedish case is presented in table 6 to illustrates this point.
Subsidy policies have similar results in low, medium, and high tax wedge
countries, as illustrated in …gure 8. As the subsidy rate increases so too does
market labor. Home work is declining in the subsidy rate, while total work is
relatively constant. Market consumption declines slightly in the subsidy rate, as
home goods consumption increases. Figure 8 outlines predicted labor supplies
(market (solid), home (dash), and total (dash-dot)) under various subsidy rates
for the U.S., France, and Sweden. The second column of …gure 8 presents
predicted consumption (market consumption(solid), home goods (dash), and
10
market inputs to home production (dash-dot)) for a range of subsidy rates for
the same countries.
Rosen (1996) argued that the welfare state encouraged excessive production of household goods and discouraged the production of material goods. If
measures are limited to market sector consumption, m, then Rosen’s critique is
correct. Predicted market inputs to home production in Sweden at the subsidy
rates this model suggests dwarf those of the U.S. Expanding the de…nition of
household goods to consider the total product of the home sector, s, the increase relative to the U.S. is more modest. Total home goods production is
only slightly greater in Sweden than in the U.S., and as …gure 8 illustrates,
home good production increases only slightly in the subsidy rate. According
to this model di¤erences in the levels of home goods production are driven by
tax distortions in the market sector not subsidies to goods like day care.
The subsidy model does well explaining the magnitudes of market and home
work observed in a broad range of O.E.C.D. countries. The model closes much
of the gap between predicted and actual market work for the Scandinavian
outliers. Allowing for small amounts of progressivity in the subsidy schedule
can bring the market sector labor supply predictions of this model in line with
the levels observed in the aggregate data.
The subsidy model illustrates quantitatively how modeling …scal policies that
subsidize market inputs to home production can generate labor supply patterns
that are consistent with the data. Fiscal policies that subsidize goods such as
day care are more complicated in reality than the simple subsidy scheme outlined
here. Yet, this exercise illustrates how variations in public expenditures on
goods like day care and elder care can explain the high levels of per capita labor
supply observed in Scandinavia. An alternative policy, where home goods are
transferred to households in amounts proportional to their market labor supply,
is examined in the next section.
4.2
Home Production with Workfare Transfers
Scandinavians work too much in the market and too little at home given the
high tax rates they face. The tax wedge may misstate the marginal incentives to
work faced by Scandinavians since many of these tax revenues are rebated back
to households as transfers indexed to their labor supply, e¤ectively reducing
the household’s marginal tax rate on labor income. Consider a policy that
provides a per unit subsidy to market labor paid out in the form of market
inputs to home production, such as publicly provided day care. The household
receives a transfer proportional to the amount of market labor they supply.
This captures the ”workfare” aspect of welfare state policies.
The household faces a similar problem as before. Let denote the proportional rebate rate at which goods like day care are transferred back to the
household. Given the government policy quadruplet ( c ; h ; ; T ) the household
11
solves the following problem:
max U (c; s; 1 h) = max ac log(c) + as log(s) + (1 ac as ) log(1 h)
s:t: (1 + c )c + m = (1
(BC3)
h )hm + T
1=
s = [a(m + hm ) + (1
)hs ]
(HHP3)
m
0; hm 0; hs 0; h = hm + hs 1:
The government transfer of household services is irreversible. The government’s
budget constraint must also be satis…ed:
T =(
h
)hm +
c c:
(GBC3)
The workfare transfer policy alters all three of the household’s …rst order
conditions. With respect to the market work decision, an additional term captures the increased bene…t of working in the market. The home work decision is
a function of the marginal utility of home services consumption where transfers
of market inputs from the public sector are included. The choice of m is also
altered by the level of . The transfer of market inputs to home production is
irreversible, m 0, so the …nal f.o.c. will not always hold with equality. The
…rst order conditions are the following:
@L
@hm
@L
@hs
@L
@m
=
=
=
as a (m + hm ) 1
1 ac
ac (1
h)
+
(1
m+T
a(m + hm ) + (1
)hs
1 hm
h )hm
as (1
)hs 1
1 ac as
=0
a(m + hm ) + (1
)hs
1 hm hs
ac
as a(m + hm ) 1
+
0:
(1
m+T
[a(m + hm ) + (1
)hs ]
h )hm
as
=(8)
0
hs
(9)
(10)
Including workfare transfers closes the entire gap between predicted and
actual market work for Norway, half the gap for Sweden and Finland, and less
for Denmark, as shown in …gure 9, and almost all of the gap between predicted
and actual home work for Norway and Sweden, half of the gap for Finland, and
slightly less for Denmark, as shown in …gure 10 and table 7 (light diamonds
denote baseline predictions for the Scandinavian outliers and dark diamonds
denote workfare transfer model predictions). The workfare model improves the
predictions of the model with respect to leisure in the Scandinavian countries as
well, as shown in …gure 11. Table 7 documents how this improvement in model
…t is greater than in the subsidy model in both dimensions of labor supply and
leisure.
A sensitivity analysis of the Swedish case is presented in table 8. Market
and home sector labor supplies are reported for various values of the transfer
rate . In order for this model to match observed levels of market labor supply
the transfer rate would need to be roughly double the rate suggested by the
aggregate data on in-kind transfers to households. If indeed other types of
public expenditures should be incorporated into our measure of , or if there
exists some progressivity in the transfer rate the workfare transfer model could
12
match the patterns of market and home sector labor supply in Sweden fairly
well.
The labor supply patterns predicted by this model are similar to those in
the subsidy model. Figure 12 presents equilibrium outcomes for a range of
workfare transfer rates for the U.S., France and Sweden. The production of
home goods is constant in in the workfare transfer rate in contrast to the slight
increasing trend in the subsidy model. Final market consumption is increasing
in the transfer rate as market work is increasing. Government expenditures
on household services as a share of output are equivalent to . Since this
transfer is irreversible, even at low levels of , the household chooses to purchase
no inputs to home production in the market. Figure 12 outlines predicted
labor supplies (market (solid), home (dash), and leisure (dash-dot)) for various
transfer rates for the U.S., France, and Sweden. The second column presents
predicted consumption (market consumption(solid), home goods (dash), market
inputs (dash-dot)) for the same countries.
The results of the workfare model are also somewhat at odds with Rosen’s
predictions. Rosen argued that welfare state home sector policies encouraged
excessive production of household goods and discouraged the production of material goods. If we look at the total consumption of home services, not just
intermediate market inputs to home goods production, we see that home goods
production is ‡at in the transfer rate as market consumption is steadily increasing.
Accounting for government consumption of home goods by way of a workfare
policy can dramatically improve the predictive power of the household production model, especially with regard to the Scandinavian countries, while still
accurately predicting labor supply for other O.E.C.D. countries. Accounting
for public expenditures on home goods increases predicted labor supply in the
market sector by 20% and reduces predicted home work by 10% for some Scandinavian countries. Accounting for public expenditures targeted at the home
sector is important for explaining labor supply patterns in the O.E.C.D. The
next chapter illustrates how accounting for the structure of home sector …scal
policies is important when evaluating the welfare implications of …scal policies.
5
Welfare Analysis
A richer model where …scal policies in‡uence the home sector directly through
subsidies and transfers of market inputs to home production can explain why
Scandinavians work so much in the market sector, despite the very high tax rates
they face. Subsidies and transfers of home goods are quantitatively signi…cant
aspects of …scal policies in the O.E.C.D. Modeling home sector …scal policies
has a large e¤ect on model predictions and the welfare analysis derived from
these models.
The home production model can quantify the welfare costs of …scal policies
in terms of total consumption, both home goods and market goods. By using
total consumption instead of market consumption alone we avoid overstating
13
the welfare costs of market sector taxes that shift production into the tax favored home sector. A welfare comparison which accounts for publicly provided
inputs to household production is presented in table 9. Observed labor supply
measures, as well as public and private inputs to home production are used to
compute utility levels. The metric for comparison is the percent increase in
total consumption, both market goods (c) and home services (s), required to
achieve a utility level comparable to the U.S. The welfare losses associated with
existing tax and transfer systems in O.E.C.D. countries are large. Consumption in some European countries would need to increase ten percent to achieve
utility levels comparable to the U.S. In contrast, the welfare losses in the high
tax wedge Scandinavian countries are less on average than in France, Germany
and Belgium. This demonstrates how home sector …scal policies can be welfare improving and can partially undo the welfare losses associated with market
sector taxes.
The following sections compare the welfare implications of the subsidy and
transfer policies under di¤erent assumptions regarding how home sector …scal
policies are funded. Case I assumes that the public sector can freely set all
…scal policies, both distortionary taxes and home sector policies, to raise some
revenue T . Subsidies and workfare transfers are not optimal in this general
second best problem. Case II takes the observed set of distortionary taxes as
given and considers how best to allocate the revenues from these taxes between
home sector …scal policies and lump sum transfers to the household sector. Since
expenditures on home sector …scal policies are funded out of forgone lump sum
transfers to households I refer to this as a limited …rst best optimal policy. Case
III is the most restrictive. Distortionary taxes and the share of consumption
dedicated to home sector …scal policies are taken as given and we consider the
optimal design of home sector …scal policies choosing between subsidies and
workfare transfers. Optimal program design can have welfare gains on the
order of half the size of the total welfare cost of the existing …scal policy in the
high tax/high public expenditure Scandinavian countries.
5.1
Case I: Fixed T
Consider the general second best optimal tax problem where the government
chooses distortionary consumption taxes, labor taxes, and home sector policies
to fund some level of public consumption denoted by the lump sum transfer
T .12 The level of public consumption, T , is taken as given and the government
chooses the policy triplet, f c ; h ; g, to maximizes household indirect utility,
V ( c ; h ; ; T ), subject to the government budget constraint given the level of
T . For the workfare policy the problem can be expressed as
( c;
h;
;T) =
f
max V ( c ;
c; h;
g
h;
; T ) + ((
1 2 Sandmo
h
)hm +
cc
T ):
(11)
(1990) considers a special case of the model presented here where market goods
are perfect substitutes for home goods.
14
Figure 13 plots the solution to this problem. The optimal policy favors consumption taxes, and does not include home sector …scal policies. The workfare
policy is not part of the second best optimal …scal policy.
5.2
Case II: Fixed
c
and
h
Institutional aspects of the public budgeting process or distributional concerns
may result in little ‡exibility to choose optimal tax rates in certain countries.
Although the tax system may be relatively …xed, …scal authorities may have
more ‡exibility in how they spend public funds than in how they raise such funds.
Given that the public sector has some set of taxes on labor and consumption this
section considers how the revenues from these taxes should be allocated between
home sector …scal policies and lump sum transfers in order to maximize utility.
Consider the optimal subsidy problem:
( ;T;
c;
h)
= max V ( c ;
f ;T g
h;
;T) + (
h hm
+
cc
T
m):
(12)
Figure 14 illustrates model predictions for utility in the U.S., France and Sweden
as subsidies to m are increased from = 0. Figure 14 reports the increase in
consumption from the baseline ( = 0) required to achieve the utility level
associate with > 0. These subsidies are …nanced by reducing the lump sum
transfer to the household sector.
The intuition for why introducing a subsidy policy in the U.S. has such a
large e¤ect relative to the other economies can be seen from evaluating the
= mj(hm ;hs ;m ; c ; h ; ;T ) ; at = 0 for each economy.
envelope condition, @V
@
Although U S < F R < SW the amount of m consumed in the U.S. is much
greater than France or Sweden at = 0 given observed taxes. These di¤erences
US
FR
SW
in m dominate @V
= 0, @V
> @V
> @V
; and as …gure 14 shows
@ : At
@
@
@
small subsidies can generate large welfare gains in low tax wedge economies.
Labor income taxes exist in all of the OECD countries considered and this tax
leads to ine¢ ciencies in home sector production decisions. Labor income taxes
drive a gap between the marginal product of home work and market services
in the production of home services. In the absence of labor taxes production
e¢ ciency would equate the marginal products of inputs to the home sector.
The subsidy policy can mitigate the ine¢ ciencies in home production caused
by labor taxation. As the subsidy to market services increases households
substitute market services for home work. Subsidy rates can be chosen so
that production e¢ ciency in the home sector is achieved, though at su¢ ciently
high subsidy rates welfare can be diminished as the marginal product of home
services is driven well below the marginal product of home work. For the case
of Sweden, the subsidy rate consistent with aggregate data, v 0:50. Figure 14
makes clear that this subsidy rate increases utility relative to the zero subsidy
case and appears to be below the subsidy rate associated with e¢ cient home
sector production.
15
Taking labor and income taxes as given, the optimal workfare transfer problem is
( ;T;
c;
h)
= max V ( c ;
f ;T g
h;
; T ) + ((
h
) hm +
cc
T ):
(13)
Model utility predictions for the U.S., France and Sweden as the workfare
transfer rate is increased from the baseline,
= 0; are presented in …gure
15. Workfare transfers are welfare increasing as they reduce the e¤ective tax
rate on labor income. Evaluating the envelope condition at = 0 provides
intuition for why the workfare policy has such a large e¤ect in Sweden relative to the U.S. and France. The envelope condition with respect to
is
du ds
ds
@V
@V
=
j
.
The
term
dominates
:
Since
is
a
trans@
ds d (hm ;hs ;m ; c ; h ; ;T )
d
@
fer of m, and the marginal product of m is greatest in the high home work/high
US
FR
SW
< @V
< @V
at = 0. The workfare
tax wedge economies we have @V
@
@
@
transfer policy has the largest e¤ect in economies where the inputs to home production are skewed toward home work and away from market inputs. The larger
the tax wedge the larger the utility gain from introducing workfare transfers.
5.3
Case II: Fixed
m
c
and
h
and Public Expenditure on
Taking tax rates and the levels of public expenditure home goods as …xed, what
form of home sector …scal policy is optimal? The problem is then a choice
between outcomes under the two policies:
max fV ( c ;
h;
; T ); V ( c ;
h;
; T )g :
(14)
Figure 16 compares outcomes under the subsidy and workfare transfer policies
for a range of home sector …scal policy expenditure levels for the U.S. and Sweden. The welfare gains associated with shifting from a workfare transfer policy
(solid line) to a subsidy policy (dashed line) at a given level of public expenditure on home sector policies is determined by the distance between these lines.
For a low tax economy like the U.S., a subsidy policy dominates the workfare
transfer policy except at very large levels of public expenditure on home goods.
The situation for a high tax wedge economy is quite di¤erent. The light solid
(transfer) and dashed (subsidy) lines in …gure 16 correspond to the case of Sweden under alternative levels of public expenditures on home sector …scal policies.
Unlike in the low tax U.S. economy the workfare transfer policy dominates the
subsidy policy at all levels of public expenditure. The gains for structuring
public expenditures as workfare transfers versus subsidies can be quite large for
a high tax wedge economy when the level of public expenditures is large. Table
10 summarizes these results for all of the countries in the sample at the public
expenditure levels observed in the data. For large tax wedge/public expenditure countries like Sweden the welfare gains associated with optimal program
design are of magnitudes similar to the total welfare losses associated with existing …scal policies presented in table 9. The optimal design of home sector
16
…scal policies depends upon the structure of market sector taxes and the size of
public expenditures on home sector …scal policies. High tax wedge economies
are better o¤ designing home sector …scal policies as workfare transfers versus
subsidies. Lower tax wedge economies like the U.K. or Spain would be best o¤
structuring public expenditures on home goods as subsidies when public expenditures are moderate. No one home sector …scal policy dominates the other for
all ranges of taxes and public expenditure levels observed in the data.
6
Conclusion
Taxes are important in explaining labor supply patterns but provide only a partial picture of how welfare state policies impact household labor supply decisions
both in the market and at home. This paper documents how labor supply shifts
into the tax favored home sector in countries where the tax wedge is large, with
the striking exception of Scandinavia. Danes, Finns, Norwegians and Swedes
work too much in the market sector and too little at home given the very high
tax rates they face.
Empirical evidence suggests that transfers of goods such as day care, which
are close substitutes for home produced goods, can have a sizable impact on
employment. By modeling the provision of home goods by the public sector this
model can close the entire gap between predicted and actual home work for the
Scandinavian outliers and half of the gap between predicted and actual market
work relative to the baseline taxes only model. Allowing for a small amount
of progressivity in home goods subsidy rates could close the entire market work
gap for these countries. Public expenditures are an important aspect of policy
and modeling the structure and design of public expenditures is important for
quantitative analysis.
How public resources are spent are as important as how revenues are raised
in explaining labor supply patterns in the market and home sector. Accounting
for home sector …scal policies is also important for welfare analysis. A limited
…rst best analysis shows how home sector …scal policies can be welfare improving,
and that the welfare gains from home sector …scal policies depend directly on the
structure of market sector taxes. The welfare gains associated with the optimal
design of home sector …scal policies, …xing taxes and expenditure levels, are half
as large as the total welfare losses of existing tax and transfer policies relative
to the U.S. for high tax/ high public expenditure countries such as Sweden.
7
References
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17
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8
8.1
Data Appendix
Labor Supply
In addition to quantifying the importance of …scal policies on households labor
supply and home production decisions this paper presents data on how households allocate their time outside the market. The large variation in market
20
work per capita across the O.E.C.D. has been well documented. The facts regarding how per capita measures of leisure and home work covary with market
work and tax measures is less well known. Successful explanations for why
labor supply varies so much between the U.S. and Europe must match these
broad facts as well as the details of how labor is allocated between the market
and home sectors.
Households work both at home and in the market and consume their remaining time as leisure. In order to …t this model to the data both market
and home sector labor supply measures are constructed. Though home work
is an important form of household labor supply, until recently there has been
little comparable data on how it varies across countries. One contribution of
this paper is the creation of home sector labor supply measures for multiple
countries.
I exclude the time that households spend sleeping, and caring for themselves
from this analysis and normalize the length of the day to 14 hours. These 14
hours per day can be allocated to a variety of activities which I will broadly
categorize as either market work, home work or leisure. On average, 49% of
the household’s 14 hour day is dedicated to working, most of this in the home
sector (26%) and slightly less in the market (23%). This summary data suggests
that the relevant question is not why do Europeans work so little, or conversely
why do they enjoy so much leisure, but why do they choose to work so much at
home? The data and de…nitions used to construct labor supply measures for
the home and market sector are described below.13
8.1.1
Market Sector Labor Supply
Studies of labor supply patterns across O.E.C.D. countries have used various
measures to quantify the labor supplied in the market sector. Here, hours
worked per person are de…ned as a function of the employment to population
ratio and the average hours worked per employed person using data from the
O.E.C.D. Labor Database. This captures both extensive and intensive labor
supply variations across countries.
Each working aged individual, those between the ages of 25-64, can allocate
14 hours a day to work, leisure, or home production. Each person in the working
age population has 5100 hours per year to allocate among these three activities.
Hours worked in the market sector are then expressed as a share of the total
time available to the population:
hm =
employment
average annual hours worked in employment
population 5100
This data is summarized in Table 11.
The O.E.C.D. hours worked data are derived from national surveys. In making cross-country comparisons we want to be con…dent that the di¤erences in
1 3 A detailed data appendix that describes how speci…c variables are constructed is available
upon request from the author.
21
market labor supply described above re‡ect di¤erences in labor supply not simply di¤erences in de…nitions of hours worked. The measurement issues related
to the O.E.C.D. labor data have been detailed in van Ark and McGuckin (1999
and 2002). Alternative data series have been constructed for many countries
that correct for di¤erences in de…nitions.14 Market work is essentially identical
across the ten countries considered regardless of the hours measure chosen.
The O.E.C.D. market work measure is used throughout this paper. The time
use studies also present some measures of market work which are presented in
Table 11. Market work is generally larger according to the time use studies
than for the labor market statistics reported by the O.E.C.D.15 . This is true
for all countries considered here, but the gap is the largest for Spain. Households in Spain report working 50% more in the market than O.E.C.D. measure
suggests. This large discrepancy between market work measures suggests that
labor supply in Spain may be mismeasured. The results reported in the body
of the paper average the TUS and O.E.C.D. market work measures for Spain.
8.1.2
Home Sector Labor Supply
Though home work is an important form of household labor supply, until recently there has been little comparable data on home work. Recent studies such
as the Harmonized European Time Use Study (HETUS) and the American Time
Use Study (ATUS) have been designed to ensure that time use information can
be compared at broad levels with information from other countries. These
studies provide comparable measures of the labor supplied in the home sector.
Home work includes activities such as food preparation, cleaning and upkeep,
construction and repairs, shopping and services, and caring for household members. Travel time related to domestic work is also included. Hours worked in
the home sector are then expressed as a share of the 14 hour day:
X
average daily domestic task hours
:
hs =
14
The time use data used to construct measures of home work share a common
focus on ’primary tasks’. As a result, the amount of time dedicated to secondary
activities such as caring for others is underreported. To illustrate this point,
if an adult is preparing a meal for a child while also supervising the child this
time will be categorized as meal preparation, not child care. In this respect the
primary child care measure understates the true amount of child care performed
1 4 See
the Groningen Growth and Development Centre and The Conference
Board, Total Economy Database, February 2004, http://www.ggdc.net.
Computing similar measures of market work using this data results in small downward revisions for the UK and Finland and a small upward revision for market work in Denmark.
All revisions are one percentage point or less.
1 5 At the time of this draft I am in the process of updating the annual hours worked measures
to re‡ect the distribution of the employed in this age group by average weekly hours bands,
and compute a more accurate average hours worked measure. This narrows much of the gap
between the TUS measures and the O.E.C.D. for most countries.
22
in the home sector since child care frequently occurs as a secondary activity.
High levels of primary ’home work’may translate into high levels of secondary
care for other household members.16 For this reason the total time dedicated
to home work is considered here.
Time spent in transportation related to home work activities is also included
in the measures of home work reported here. This convention follows the format
adopted by the ATUS and the Canadian Time Use Study. The time use data
for the European countries compiled as part of HETUS tracks transportation
time separately. To make the time use data comparable across studies time
spent in home work related transportation has been included in the measure of
home work.
To construct a home work measure for the working age population (ages 2564) time use for various age groups is aggregated up using population weights
from the O.E.C.D. For the case of Denmark time use data is not disaggregate
su¢ ciently to construct a precise measure of home work for the population aged
25-64. To address this a scaling factor is computed from other Scandinavian
countries by comparing home work measures for the larger sample to home work
measures from the working age sample and home work measures for Denmark
are adjusted proportionally.
8.2
Tax Rates
Macroeconomic analysis of …scal policy highlights the important role of distortionary taxation in the allocation of economic resources. Labor income and
consumption taxes are an important part of the analysis presented in this paper. The following sections outline the empirical tax rate measures used here
and compares them alternative measures.
8.2.1
Labor Income Taxes
Lucas (1990) considers ‡at rate taxes in his seminal study of capital taxation.
In this vein, Mendoza, Razin and Tesar (1994) and others outline methods for
computing tax rates using national accounts data. Joines (1981), as extended
by McGrattan (1994), uses national accounts data and aggregate tax return data
to compute marginal tax rate measures for labor and capital using U.S. data.
Barro and Sahasakul (1986), as extended by Mulligan and Marion (2004), use
aggregate tax return data to estimate average marginal tax rates from the federal
individual income tax for 1916-1980. The O.E.C.D. constructs marginal tax rate
measures for an ”average production worker”(APW). Each of these approaches
imposes strong assumptions and data requirements to generate measures of labor
income tax rates.
1 6 Primary child care activities are limited to physical care; playing with children; reading
to children; assistance with homework; attending children’s events; taking care of children’s
health care needs; and dropping o¤, picking up and waiting for children. Passive childcare
when done as a primary activity is also included as a primary childcare, and example being
watching your children while swimming. Watching television with your child is considered
leisure, not childcare.
23
A comparable, yet simpler, method is proposed by Prescott (2002, 2004).
Prescott uses a standard growth model as a guide to decompose aggregate national accounts data and compute consumption and labor income tax rates for
the U.S. and several other O.E.C.D. countries. Figure 17 illustrates how similar
Prescott’s measure is to other tax rate measures. The Prescott measure is essentially identical to both the Barro-Sahasakul/Marion-Mulligan measure and the
O.E.C.D. labor income tax measures during the 1990’s, the period considered
in this paper.
The labor income tax measure suggested by Prescott is a good proxy for
marginal tax rates on labor income in the U.S. Extending this measure to other
countries requires data on income shares and the concavity of the tax schedules
that exist in these countries. Gollin (2002) presents a detailed analysis of
income shares across nations which I use in computing average taxes on labor
income following Prescott’s methodology. These average tax rate measures are
similar to those computed by Carey et al (2002) in their extension of Mendoza
et al (1994) to a broader group of O.E.C.D. countries. The ordering of labor
income tax rates across countries is similar under both measures.
To generate marginal tax rates, information about the concavity of tax functions is required. With little comparable information on tax progressivity in the
countries analyzed here I have assumed that the relationship between average
and marginal tax rates is similar to that in the U.S. Though Prescott’s measure
of labor tax rates …ts U.S. levels as well as the relative di¤erences across countries one may wonder whether these imputed tax values are too high for other
countries, in particular the Scandinavian countries. If the tax measures chosen
are systematically overstating the tax distortions faced by Scandinavian households this could create the illusion that labor supply in Scandinavian countries
is too high, relative to predicted values, when in fact it is the tax measure that is
too large. Ljunge and Ragan (2005) use micro data to compute marginal labor
income tax rates for a representative sample of the Swedish population. The
income weighted marginal tax rate on labor income they computed is approximately identical to the rate computed using the measure proposed by Prescott.
Prescott’s marginal income tax measure tracks the marginal tax rate measure
proposed by Ljunge and Ragan (2005) very closely during the 1990’s, as shown
in Figure 18.
8.2.2
Consumption Taxes
Consumption taxes are computed as in Prescott (2002) using national income
and product account data. Indirect taxes less subsidies are treated as net taxes
on output. It is assumed that two thirds of these net taxes falls directly on
private consumption expenditures and that the remaining one third is distributed evenly over total product. The motivation for this assignment of indirect
taxes, Prescott argues, is that most indirect taxes fall on consumption whether
as value added taxes, sales taxes, excise taxes, or as property taxes. Some taxes,
such as fuel taxes on diesel fuel used by trucks that transport goods, property
taxes on o¢ ce building, and sales taxes on equipment purchases by businesses,
24
fall on all forms of output. The consumption tax rate is then computed as the
ratio of these indirect taxes to consumption net of indirect tax.
8.3
Public Expenditures
In order to quantify public expenditures on …scal policies directed at the home
sector we use data from the O.E.C.D. Social Expenditures (SOCX) database.
SOCX describes government expenditures on subsidies, cash transfers and direct
service provision at a detailed level. Table 4 details public expenditures on the
provision of services that substitute for home goods as a share of consumption
net of indirect taxes.
There are generally three groups of countries with respect to home services
expenditure. Belgium, Canada, Spain and the U.S. spend small amounts on
home services as a share of consumption. France, Germany, the Netherlands
and the U.K. spend somewhat more, approximately two percent of consumption
net of indirect taxes. The Scandinavian countries spend much more, around
eight percent of consumption, on publicly provided home goods.
The variation in home services expenditures by the public sector across countries is notable. Total government consumption in Denmark is double that of
the U.S., yet the share of home services provided by the public sector is on the
order of 20 times greater. This variation in public expenditure on home services
is an important aspect of the welfare state.
9
Figures and Tables
25
% Difference Relative to the U.S.
30
20
10
0
-10
UK
(+7)
SP
(+12)
CA
(+27)
FR
(+45)
GER
(+45)
BE
(+56)
NO
(+63)
SW
(+84)
-20
-30
Ordered by the Tax Wedge
(% Difference in Tax Wedge Relative to the U.S.)
Market Work
Home Work
Figure 1: Time Use Relative to the U.S.
26
Leisure
FI
DK
(+84) (+166)
0.28
U.S.
0.26
Sweden
0.24
U.K.
Canada
Finland
Spain
Actual
0.22
Norway
France
Germany
Belgium
Denmark
0.2
0.18
0.16
0.14
0.12
0.1
0.1
0.12
0.14
0.16
0.18
0.2
0.22
0.24
0.26
Predicted
Figure 2: Market Work in the Baseline Model (Taxes Only)
27
0.28
0.3
0.3
Actual
Belgium
France
Spain Germany
U.K.
Canada
Sweden
U.S.
Finland
Norway
Denmark
0.25
0.2
0.15
0.15
0.2
0.25
0.3
Predicted
Figure 3: Home Work in the Baseline Model (Taxes Only)
28
0.35
0.58
0.56
Denmark
0.54
Norway
Germany
France
Actual
0.52
Finland
SpainCanada Belgium
Sweden
U.K.
0.5
U.S.
0.48
0.46
0.44
0.42
0.4
0.4
0.42
0.44
0.46
0.48
0.5
0.52
0.54
0.56
Predicted
Figure 4: Leisure in the Baseline Model (Taxes Only)
29
0.58
0.6
0.28
U.S.
0.26
Sweden
Finland
0.22
Actual
U.K.
Canada
Spain
Norway
France
Germany
Belgium
0.24
Denmark
0.2
0.18
0.16
0.14
0.12
0.1
0.1
0.12
0.14
0.16
0.18
0.2
0.22
0.24
Predicted
Figure 5: Market Work in the Subsidy Model
30
0.26
0.28
0.3
0.3
Actual
Belgium
U.K.
0.25
Germany
Spain France
Canada
Sweden
U.S.
Finland
Norway
Denmark
0.2
0.15
0.15
0.2
0.25
Predicted
Figure 6: Home Work in the Subsidy Model
31
0.3
0.35
0.58
0.56
Denmark
0.54
Norway
Germany
France
Actual
0.52
Finland
SpainCanada Belgium
Sweden
U.K.
0.5
U.S.
0.48
0.46
0.44
0.42
0.4
0.4
0.42
0.44
0.46
0.48
0.5
0.52
0.54
Predicted
Figure 7: Leisure in the Subsidy Model
32
0.56
0.58
0.6
Labor and Leisure
Consumption
h
h
U.S.
0.4
0.4
0.3
s
1-h
0.2
0.2
0
c
s
m
m
0.1
0
0.1
0.2
0.3
0.4
0
0.5
0
0.1
0.2
0
0.1
0.2
0.3
0.4
0.5
FRANCE
0.4
0.3
0.4
0.2
0.2
0
0.1
0
0.1
0.2
0.3
0.4
0
0.5
SWEDEN
0.6
0.3
0.4
0.5
0.4
0.3
0.4
0.2
0.2
0
0.1
0
0.2
0.4
Subsidy Rate, ν
0.6
0
0
0.2
0.4
Subsidy Rate, ν
Figure 8: Time Use & Consumption in Three Tax Regimes (Subsidy Policy)
33
0.6
0.28
U.S.
0.26
Sweden
Canada U.K.
Spain
Norway
France
Germany
Belgium
0.24
Finland
Actual
0.22
Denmark
0.2
0.18
0.16
0.14
0.12
0.1
0.1
0.12
0.14
0.16
0.18
0.2
0.22
0.24
Predicted
Figure 9: Market Work in the Workfare Model
34
0.26
0.28
0.3
0.3
Actual
Belgium
U.K. Spain
0.25
Germany
France
Sweden
Canada
U.S.
Finland
Norway
Denmark
0.2
0.15
0.15
0.2
0.25
Predictied
Figure 10: Home Work in the Workfare Model
35
0.3
0.35
0.58
0.56
Denmark
Norway
Germany
Finland
France
0.54
Actual
0.52
Belgium
Spain CanadaSweden
0.5
U.K.
U.S.
0.48
0.46
0.44
0.42
0.4
0.4
0.42
0.44
0.46
0.48
0.5
0.52
0.54
Prediction from the Workfare Model
Figure 11: Leisure in the Workfare Model
36
0.56
0.58
0.6
Labor and Leisure
Market and Home Sector Consumption
h
h
U.S.
0.4
0.2
s
1-h
0.2
FRANCE
0
0.1
0
0.02
0.04
0.06
0.08
0.1
0
0.4
0.2
0.2
0.1
0
SWEDEN
c
s
m
m
0
0.02
0.04
0.06
0.08
0.1
0
0.6
0.3
0.4
0.2
0.2
0.1
0
0
0.02
0.04
0.06
Transfer Rate, φ
0.08
0.1
0
0
0.02
0.04
0.06
0.08
0.1
0
0.02
0.04
0.06
0.08
0.1
0
0.02
0.08
0.1
0.04
0.06
Transfer Rate, φ
Figure 12: Time Use & Consumption in Three Tax Regimes (Workfare Policy)
37
Figure 13: Optimal Fiscal Policies (Fixed T )
38
0.06
U.S.
France
Sweden
Increase in Total Consumption (c + s)
0.04
0.02
0
-0.02
-0.04
-0.06
0
0.1
0.2
0.3
Subsidy Rate, ν
0.4
0.5
Figure 14: Subsidy Policy Welfare Gain for Three Tax Regimes
39
0.06
U.S.
France
Sweden
Increase in Total Consumption
0.04
0.02
0
-0.02
-0.04
-0.06
0
0.01
0.02
0.03
0.04
0.05
0.06
Transfer Rate, φ
0.07
0.08
0.09
Figure 15: Workfare Policy Welfare Gain for Three Tax Policies.
40
0.1
0.07
Subsidy -US
Transf er-US
Subsidy -SWE
Transf er-SWE
Increase in Total Consumption (c and s)
0.06
0.05
0.04
0.03
0.02
0.01
0
0
0.01
0.02
0.03
0.04
0.05
0.06
0.07
0.08
0.09
0.1
Expenditure on Home Sector Fiscal Policies as a Share of Consumption
Figure 16: Subsidy and Workfare Welfare Comparisons for Two Tax Regimes
41
0.40
0.35
0.30
0.25
0.20
0.15
1975
1980
1985
1990
1995
Year
Prescott
Barro Sahasakul
OECD
Figure 17: Labor Income Tax Rate Measures for the U.S.
42
0.7
0.6
0.5
0.4
0.3
0.2
0.1
Prescott
95
19
93
19
91
19
89
19
87
19
85
19
83
19
81
19
19
79
0
Ljunge-Ragan
Figure 18: Labor Income Tax Rate Measures for Sweden
43
Baseline Household Production Model
Country
Tax
Wedge
U.S.
U.K.
Spain
Canada
France
Germany
Belgium
Norway
Sweden
Finland
Denmark
1.64
1.76
1.84
2.09
2.37
2.38
2.56
2.67
3.01
3.02
4.37
Market Work
Actual Predicted
0.27
0.24
0.23
0.24
0.21
0.20
0.20
0.22
0.25
0.24
0.22
R.M.S.E.
0.27
0.26
0.25
0.22
0.20
0.20
0.19
0.18
0.16
0.16
0.12
Home Work
Actual Predicted
0.25
0.26
0.27
0.26
0.27
0.27
0.29
0.25
0.25
0.25
0.24
0.0475
Leisure
Actual Predicted
0.25
0.25
0.26
0.27
0.28
0.28
0.28
0.29
0.29
0.29
0.31
0.48
0.49
0.51
0.50
0.52
0.52
0.51
0.54
0.54
0.52
0.54
0.0313
0.48
0.49
0.49
0.51
0.52
0.52
0.53
0.53
0.53
0.54
0.57
0.0199
Time use is expressed as shares of a 14 hour day for individuals aged 25-64.
To convert shares into weekly hours worked for the typical worker divide
by the fraction of the population in employment and multiply by the available
hours per week. For the U.S. 76% of the population works on average 36
hours per week. For Germany 67% of the population works approximately
30 hours per week. In Sweden 79% of thepopulation works approximately
30 hours per week. Tax wedge refers to the ratio of one plus the
consumption tax rate to one minus the marginal tax rate on labor income, 11+ hc .
Market work is computed from O.E.C.D. Labor Market Statistics. Market
work in Spain is the average of the O.E.C.D. measure and the TUS measure.
Home work is computed from the ATUS, CTUS and HETUS, see the
Data Appendix. Leisure is de…ned as the remainder of the day.
Table 1: Evaluating the Baseline Household Production Model - Taxes Only
hm
0.25
0.25
hs
0.27
0.27
m
m+c
h
c
0.025
0.025
0.32
0.32
0.12
0.12
0.9
0.6
ac
0.37
0.37
as
0.22
0.22
a
0.51
0.28
Table 2: Parameter Calibration for Alternative Values of
Panel Regression of Employment Rates on
Welfare State Expenditures Expressed as Shares of Consumption
Variable
Coe¢ cient
Range of Variation
(t-statistic)
min
max
Time E¤ect
5.31
Tax Wedge
-1.79
1.47
-4.39
(-3.04)
Employment Reducing Expenditures
Unemployment Insurance
-2.22
4.89
-12.36
(-4.97)
Disability Insurance
-1.71
3.57
-8.50
(-2.71)
Social Security
-0.88
4.65
-7.98
(-2.06)
Employment Increasing Expenditures
Day Care
2.87
-2.24
6.95
(4.55)
Injury Bene…ts
1.81
-0.90
1.69
(1.98)
Sickness Bene…ts
1.37
-1.33
4.30
(1.67)
Survivors Bene…ts
2.62
-4.31
7.08
(1.19)
Family Cash Bene…ts
0.55
-0.94
1.38
(1.04)
Health Bene…ts
0.36
-1.41
1.28
(0.79)
Other Controls
Union Density
-0.13
4.21
-5.68
(-1.38)
Country Fixed E¤ects
Yes
t-statistics computed using robust standard errors clustered by country.
Bolded coe¢ cients denote signi…cance at the 10% level. Public
expenditures are expressed as shares of public and private consumption
net of indirect taxes. 16 countries included for 1980-1997 period.
Table 3: The Employment E¤ects of Fiscal Policies in the O.E.C.D.
Public Expenditures on Bene…ts in Kind
Expressed as Shares of Consumption
Country
Family
Services
Elderly
Services
Total
Services
U.S.
Belgium
Canada
Spain
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
U.K.
France
Germany
0.01
0.01
0.01
0.01
0.01
0.01
0.02
0.02
0.02
Finland
Norway
Sweden
Denmark
0.02
0.02
0.03
0.03
0.02
0.06
0.05
0.05
0.05
0.08
0.08
0.08
Social expenditure data are from the O.E.C.D.
SOCX database, (categories 5 & 8). Expenditure
data are expressed as shares of consumption
net of indirect taxes. Values are averages
for the 1993-1996 time period.
Table 4: Public Expenditures on Bene…ts in Kind in the O.E.C.D.
Household Production Model with Subsidies
Country
Tax
Wedge
Subsidy
Rate,
U.S.
U.K.
Spain
Canada
France
Germany
Belgium
Norway
Sweden
Finland
Denmark
1.64
1.76
1.84
2.09
2.37
2.38
2.56
2.67
3.01
3.02
4.37
0.00
0.14
0.13
0.00
0.29
0.30
0.00
0.42
0.49
0.46
0.59
Market Work
Actual Predicted
0.27
0.24
0.23
0.24
0.21
0.20
0.20
0.22
0.25
0.24
0.22
0.27
0.29
0.25
0.22
0.22
0.21
0.19
0.23
0.20
0.18
0.14
Home Work
Actual Predicted
0.25
0.26
0.27
0.26
0.27
0.27
0.29
0.25
0.25
0.25
0.24
0.25
0.22
0.25
0.27
0.26
0.26
0.28
0.24
0.26
0.27
0.29
Leisure
Actual Predicted
0.48
0.49
0.51
0.50
0.52
0.53
0.51
0.54
0.50
0.52
0.54
0.48
0.49
0.49
0.51
0.52
0.52
0.53
0.54
0.55
0.55
0.58
Subsidy Model R.M.S.E.
0.0406
0.0211
0.0216
(Baseline Model R.M.S.E.)
(0.0475)
(0.0313)
(0.0199)
Time use is expressed as shares of the 14 hour day for the average individual aged 25-64.
Subsidy rates are computed by matching public expenditures to those observed in the data.
Table 5: Evaluating the Household Production Model with Subsidies
Subsidy Model
Sensitivity Analysis for Sweden
Subsidy
Rate,
Market
Work, hm
Home
Work, hs
0.49
0.50
0.52
0.53
0.54
0.55
0.20
0.20
0.21
0.23
0.24
0.25
0.00
0.14
0.13
0.00
0.29
0.30
0.27
0.24
0.23
0.24
0.21
0.20
Actual
0.25
0.25
0.50
1
Leisure
hm hs
Table 6: Subsidy Model Sensitivity Analysis for Sweden
Household Production Model with Workfare Transfers
Country
Tax
Wedge
Workfare Transfer
Rate,
U.S.
U.K.
Spain
Canada
France
Germany
Belgium
Norway
Sweden
Finland
Denmark
1.64
1.76
1.84
2.09
2.37
2.38
2.56
2.67
3.01
3.02
4.37
0.00
0.02
0.00
0.00
0.02
0.02
0.00
0.08
0.08
0.05
0.08
Market Work
Actual Predicted
0.27
0.24
0.23
0.24
0.21
0.20
0.20
0.22
0.25
0.24
0.22
0.27
0.27
0.25
0.22
0.21
0.21
0.18
0.22
0.20
0.18
0.14
Home Work
Actual Predicted
0.25
0.26
0.27
0.26
0.27
0.27
0.29
0.25
0.25
0.25
0.24
0.25
0.25
0.26
0.27
0.27
0.27
0.28
0.26
0.27
0.28
0.29
Leisure
Actual Predicted
0.48
0.49
0.51
0.50
0.52
0.53
0.51
0.54
0.50
0.52
0.54
0.48
0.49
0.49
0.51
0.52
0.52
0.53
0.52
0.54
0.54
0.57
Workfare Model R.M.S.E.
0.0333
0.0198
0.0176
(Baseline Model R.M.S.E.)
(0.0475)
(0.0313)
(0.0199)
Time use is expressed as shares of the 14 hour day for the average individual aged 25-64.
Workfare transfer rates are computed by matching public expenditures to those observed in the data.
Table 7: Evaluating the Household Production Model with Workfare Transfers
Workfare Model
Sensitivity Analysis for Sweden
Workfare Transfer
Rate,
Market
Work, hm
Home
Work, hs
0.08
0.10
0.12
0.15
0.16
0.18
0.20
0.21
0.22
0.23
0.24
0.25
0.27
0.26
0.25
0.25
0.24
0.23
0.54
0.53
0.53
0.53
0.53
0.53
Actual
0.25
0.25
0.50
1
Leisure
hm hs
Table 8: Workfare Model Sensitivity Analysis for Sweden
Welfare Comparison Using the Workfare Model
Evaluated at Observed Labor Supply and Consumption Levels
Increase in Consumption Required to Achieve U.S. Utility
% Increase
Total Consumption
c+s
Actual
Market Work
hm
Actual
Home Work
hs
Actual
m Share
U.S.
U.K.
Spain
Canada
0.0
3.3
5.0
3.5
0.27
0.24
0.23
0.24
0.25
0.26
0.27
0.26
0.03
0.03
0.02
0.02
France
Germany
Belgium
8.3
10.2
10.3
0.21
0.20
0.20
0.27
0.27
0.29
0.04
0.04
0.02
Norway
Sweden
Finland
Denmark
8.3
3.9
4.9
8.9
0.22
0.25
0.24
0.22
0.25
0.25
0.25
0.24
0.09
0.10
0.07
0.09
m
m+c
Table 9: Welfare Comparison Using the Workfare Model and Observed Labor
Supply and Consumption Levels
Welfare Comparison of Home Sector Fiscal Policies
Fixing Tax Rates and the Level of Public Expenditures
Increase in Consumption Under the Workfare Policy
Required to Achieve the Subsidy Policy Utility Level
Model Generated Comparisons
% Increase
Total Consumption
c+s
Tax
Wedge
U.S.
U.K.
Spain
Canada
0.0
0.7
0.4
0.0
1.64
1.76
1.84
2.09
0.00
0.02
0.00
0.00
France
Germany
Belgium
-0.2
-0.2
0.0
2.37
2.38
2.56
0.02
0.02
0.00
Norway
Sweden
Finland
Denmark
-2.4
-3.1
-1.9
-4.4
2.67
3.01
3.02
0.22
0.08
0.08
0.05
0.08
1+
1
c
h
Public
Expenditures
hm , m
Positive consumption changes imply the subsidy policy is preferred.
Negative consumption changes imply the workfare policy is preferred.
Table 10: Comparing Welfare Under the Subsidy Versus Workfare Transfer
Policy
73