Loss aversion, labor supply, and income taxation

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Abstract

We assume that taxpayers are loss averse in reference to other taxpayers’ consumption. Loss aversion implies that labor supply responses to taxation depend on the taxpayer's position in the income distribution. Consistent with empirical evidence, we find the steeper the ascent on the curve of income distribution, the smaller the labor supply elasticity. In the standard problem of optimal income taxation, the role of income distribution is to aggregate the labor supply effects of taxation. We show that loss aversion can offset the aggregation role of income distribution resulting in a greater role for social concerns.

Original languageEnglish
Pages (from-to)579-598
Number of pages20
JournalThe Scandinavian Journal of Economics
Volume124
Issue number2
Early online date10 Nov 2021
DOIs
Publication statusPublished - 30 Apr 2022

Keywords

  • Income taxation
  • labor supply
  • loss aversion
  • reference dependence
  • social welfare

ASJC Scopus subject areas

  • Economics and Econometrics

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