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This paper presents estimates of the employment and welfare effects
of personal labour income taxation in Estonia. The labour supply decision
of individuals is estimated based on data from the 2005 Estonian
Labour Force Survey. Economic incentives are found to affect the participation
decisions of individuals, but not the number of hours worked
by individuals already working. The participation elasticities are higher
for individuals in the middle income groups than for individuals in the
low and high income groups. Increasing the proportional tax rate by 1
percentage point is found to reduce total employment by 0.35 percentage
points. The baseline estimate of the marginal cost of public funds
is 1.6 if the proportional tax rate is increased and 1.8 if the basic exemption
is lowered. The marginal cost of public funds varies across
different income groups, which may suggest possible gains in efficiency
from reallocating the taxation burden of the existing system of proportional
taxation. The employment and welfare estimates are subject to
substantial uncertainty.
JEL Code: H21, H24, J21, J22
Key words: taxation, labour supply, welfare, excess burden
*The author would like to thank David G. Mayes, Alari Paulus and Tairi Rõõm as well as seminar participants at the Bank of Estonia, the University of Tartu, the 9th ASPE Conference in St. Petersburg and the EcoMod2008 International Policy Modelling Conference in Berlin for useful comments. Ülle Pettai from Statistics Estonia has readily answered numerous questions concerning the data used. Kairi Ani, Tanel Liiv and Andres Võrk have helped with information on data and tax legislation. The author is solely responsible for any remaining errors and omissions.
Author's e-mail address: karsten.staehr@epbe.ee
The views expressed are those of the author and do not necessarily represent the official views of Eesti Pank.
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