Transcript Contemporary Labor Economics

Chapter 12
Government and the Labor
Market: Employment,
Expenditures, and Taxation
McGraw-Hill/Irwin
Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved.
1.Public-Sector
Employment
and Wages
12-2
Government Employment
• The growth
of federal
employment
has been
much smaller
than the
growth at the
state and local
level.
25.0
20.0
Millions
• The number
of federal
civilian and
state and local
government
employees has
risen over
time.
15.0
10.0
5.0
0.0
1950 1960 1970 1980 1990 2000 2004 2006 2008
Federal Civilian
Military
State and Local
12-3
• This increase
is due to
increased
demand for
government
services due to
factors such as
the schooling
needs of the
baby boom,
higher real
income, public
sector unions,
and increased
regulation.
16.0%
14.0%
12.0%
Millions
• The share of
employment in
the public sector
has risen over
time.
Relative Government
Employment
10.0%
8.0%
6.0%
4.0%
2.0%
0.0%
1950 1960 1970 1980 1990 2000 2004 2006 2008
Federal Civilian
State and Local
12-4
Public vs. Private Pay
o Most government units attempt to set
pay equal to those to comparable
private-sector workers.
o In the past, Federal government workers
earned premium relative to their private
sector counterparts.
• The premium has fallen over time.
o Public sector workers receive a greater
fraction of their compensation in the form
of fringe benefits.
12-5
2. The Military Sector:
The Draft Versus
the Voluntary Army
12-6
Draft vs. Voluntary Army
o Before 1973, the military used to draft
or compel people to serve in the
military.
• The pay for those serving in the military
was low.
o In 1973, military switched to an all
volunteer army.
• Military pay was raised significantly.
12-7
Draft vs. Voluntary Army
• If the military drafts OG
number of workers and pays
them OA, the wage bill to
taxpayers (OAfG) will be less
than the total opportunity costs
(OBcG) to those drafted.
• Under a voluntary system,
the relevant demand curve
becomes Dv, the cost to
taxpayers increases (OBeH as
compared to OAfG), those
who volunteer are fully
compensated for their
opportunity costs (OBeH) and
the military is likely to reduce
its total workforce (OG to OH).
• The true cost of employing
any specific group of workers
is independent of the wage
bill.
Dd
Wage rate
c
e
S
B
f
A
Dv
O
H
G
Quantity of
Labor Hours
12-8
Question for Thought
1. Explain why a voluntary army may be less
expensive to society than an army composed of
draftees. Which will be less expensive to
taxpayers?
12-9
3. Nonpayroll Spending
by Government:
Impact on Labor
12-10
Government Purchases
of Private-Sector Output
o Government purchases include
procurement of items such as computers,
tanks, paper clips, and weather satellites.
o This spending creates a derived demand
for workers who make these kinds of
products.
o In sectors where the government is a
larger purchaser, changes in government
spending will affect the wages and
employment of workers.
12-11
Transfer Payments and Subsidies
o Transfer payments such as Social Security
and unemployment compensation transfer
income from the government to individuals and
families.
• Recipients provide no current productive activities in
return.
o Subsidy is a transfer payment for firm,
institution, or household that consumes or
provides a specific good or service.
• For example, Medicare for the elderly and public
education for youth
12-12
Demand Effects
o Transfer payments and subsidies
increase the product demand by
certain groups of individuals and
families.
o This will translate into higher derived
demand for workers that make those
products.
• Medicare programs increase the demand
for workers in the medical field.
12-13
Supply Effects
o Transfer payments create an income effect
that reduces work effort by recipients.
• The payments increase income that enable recipients
to purchase more of all goods including leisure.
o If the transfer payment is inversely related
to earned income, then it creates a
substitution effect that reduces work effort
by recipients.
• This occurs because the opportunity cost of leisure is
reduced.
12-14
Supply Effects
o Transfers and subsidies may also
reduce long-run labor supply decisions.
• Transfers may reduce the incentive to
invest in human capital since the gains
from education are reduced by the loss in
transfer payments.
o Transfers and subsidies may increase
long-run labor supply decisions.
• If the government lowers the private cost of
education, then the incentive to invest in
human capital is greater.
12-15
4. Labor Market Effects
of Publicly Provided
Goods and Services
12-16
Demand Effects
o Provision of a public good that is a
complement in either consumption or
production of a private good will increase
the demand for workers who help produce
the private good.
• A new dam will increase the demand for farm
workers due to more irrigation.
o Provision of a public good that is a
substitute in either consumption or
production of a private good will decrease
the demand for workers who help produce
the private good.
12-17
Supply Effects
• If real income is defined as
the total quantity of public and
private goods and services
obtainable from any specific
level of work, then the
presence of $60 per day of
public sector goods causes a
parallel shift of the budget
constraint.
• Assuming leisure to be a
normal good and disregarding
the tax consequences of the
increased public-sector
provision, this creates an
income effect that increases the
optimal number of hours of
leisure by 1 hour (and reduces
work effort by 1 hour).
Public &
Private
Goods
$300
$240
U2
U1
I2
I1
0
16 17
24
Leisure
12-18
Question for Thought
1. Assuming that “income” includes both private
and public goods, and that leisure is a normal
good, explain how a major reduction in
governmentally provided goods might increase a
person’s optimal number of hours of work.
12-19
5. Income Taxation
and the Labor Market
12-20
Wages and Employment:
Inelastic Labor Supply
• The demand curve D is the
before-tax wage rate that firms
face.
• If the labor supply curve is
perfectly inelastic (S), then the
quantity of labor supplied does
not depend on the wage rate.
• Without an income tax, the
market wage is $18.00.
30.00
• With an income tax, the aftertax demand curve facing the
worker is Dt.
• The amount of the tax is
measured by the vertical
distance between D and Dt.
($18.00-$14.40=$3.60).
14.40
• Since the pre-tax wage does
not change, workers bear all of
the burden of the income tax.
S
Wage rate
a
18.00
b
D
Dt
0
6
Quantity of
Labor Hours
12-21
Wages and Employment:
Positive-Sloped Supply
• If the labor supply curve is
positively-sloped (S), then the
quantity of labor supplied
depends on the wage rate.
• Without an income tax, the
market wage is $18.00.
• With an income tax, the
equilibrium hours work drops
from 6 to 5.
• As a result, the pre-tax wage
will rise to $20.00. The after-tax
wage will be $15.50.
• Since the pre-tax wage rises,
firms bear some of the burden
of the income tax.
• The greater the elasticity of
labor supply, the larger is the
employment loss and the
greater is the rise in the wage
rate.
Wage rate
S
30.00
20.00
18.00
15.50
a
b
D
Dt
0
5 6
Quantity of
Labor Hours
12-22
Income Tax and Individual
• An income tax shifts the Labor Supply
after-tax wage downward and
may either raise or lower a
person’s optimal number of
hours of work.
Income/day
• Prior to the income tax, the
optimal hours of work is 9 (15
hours of leisure) at point U1.
$360
• After the income tax, the
optimal hours of work
decreases to 8 (16 hours of
leisure) at point U2. This
implies the substitution effect
caused by the tax is larger
than the income effect.
• The optimal hours of work
would increase if the income
effect was larger than the
substitution effect.
U1
$240
U2
I2
I1
0
15 16
24
Leisure
12-23
Caveat
o The presence of the income tax will
likely increase the amount of public
goods which will produce an income
effect, which will reduce hours of work.
• This will end to offset the income effect of
the income tax which tends to increase
hours of work.
• As a result, only a substitution effect may
remain and thus the income tax may
reduce labor supply.
12-24
Empirical Analysis
o For men, the income effect tends to
slightly outweigh the substitution effect.
• The income tax tends to slightly raise
hours of work for men.
o For women, the substitution effect
outweighs the income effect.
• The income tax tends to lower hours of
work for women.
o In the aggregate, labor supply is highly
inelastic and so workers bear most of
the burden of the income tax.
12-25