Tax rates, labor supply, and the structure of preferences

This article examines the labor supply response to a change in the income tax rate when tax revenues finance the provision of government goods. It first shows that even if taxpayers value government goods directly as equivalent income, there will still exist an income effect. It then discusses the nature of the “income effect” and the issues of complementarity and substitutability that arise when government goods are not valued as equivalent income. Finally, it proves that there is no income effect associated with a cut in the income tax rate if and only if preferences are weakly separable between private and government goods and linear in nonleisure private goods.