INCOME TAX AND LABOR SUPPLY

Abstract

Income Tax and Labour supply is an important part in public sector Economics. Income tax affects labour supply which in turn affects the national income. Economic theory cannot predict the effect of tax on Labour supply, because are in opposite directions. This research is concerned with the effect substitution and income effects of taxation on labour supply by an econometric study of cross-sectional data. It is assumed that the effect of taxation is to alter budget constraints. Because different individuals have different gross wage rates and different amounts of other income, they have different budget constraints. If difference in preferences are adequately controlled for, it is possible to derive labour supply estimates from the cross-sectional data which can then be used as basis for estimating the effect of taxation. In this study we show that the effects of net wage rate on labour supply is significant, that non wage income is not significant. We finally recommend a policy for tax refoRm by changing the marginal tax rate.