Tax Incidence With Variable Labor Supply

Abstract

Using a dynamic optimization model in which the rate of time preference is endogenously determined by a household's aggregate utility, it is demonstrated that variability in labor supply has a significant effect on the long-run incidence of a capital income tax. It is demonstrated that if there is a marginal increase in the capital income tax rate, the tax burden is shared in some proportion by both capital and labor, with capital's share of the tax burden increasing with increasing elasticity of labor supply. This is in contrast with earlier results that showed that the elasticity of labor supply has no effect on the long-run incidence of a factor tax.