Home production and the welfare cost of labour supply tax distortions

Abstract

The traditional model of household labour supply incorporates leisure into preferences rather than focusing on how relative costs of production at home and via market activity determine market labour supply. In part, this reflects the lack of simple closed form solutions for the home production model. This article uses numerical techniques to compare the welfare costs of tax distortions of labour supply in models with and without home production. When observationally equivalent models of each type are calibrated to the same aggregate labour supply elasticity, the home production model of labour supply produces a much smaller welfare cost of tax distortions of labour supply than the standard model. Our results thus suggest that home production is important for understanding the welfare effects of labour tax policies.

Keywords:

• welfare cost
• labour supply
• home production
• tax distortions

JEL Classification:

• J20
• J22

Notes

¹ Becker (1965), Gronau (1977, 1986), Greenwood and Hercowitz (1991), etc.

² Ballard, et al. (1985), Bhattarai and Whalley (2003), etc.

³ Becker (1965), Gronau (1977, 1986), Benhabib et al. (1991), Greenwood and Hercowitz (1991), etc.

⁴ A typical individual has about 70 hours of available time per week and works for 40 hours.

⁵ See Bhattarai and Whalley (2003) for a detailed explanation of this estimate.

⁶ Examples of such goods are home services, such as personal care.