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Working Paper Series
Does Redistribution Increase Output?
The Centrality of Labor Supply
WP 14-04R
Kartik Athreya
Federal Reserve Bank of Richmond
Andrew Owens
Federal Reserve Bank of Richmond
Felipe Schwartzman
Federal Reserve Bank of Richmond
This paper can be downloaded without charge from:
http://www.richmondfed.org/publications/
Does Redistribution Increase Output? The Centrality of Labor
Supply∗†
Kartik Athreya‡
Andrew Owens§
Felipe Schwartzman¶
December 8, 2014
Working Paper 14-04R
Abstract
The aftermath of the recent recession has seen numerous calls to use transfers to poorer
households as a means to enhance aggregate activity. The goal of this paper is to study the
effects of wealth redistribution from rich to poor households on consumption and output in
the short run. We show that in a standard incomplete-markets model extended to allow for
nominal rigidities and parametrized to match the wealth distribution in the U.S. economy,
wealth redistribution does lead to a temporary boom in consumption, but not in output. We
then show, both analytically and numerically, that the key to understanding the direction and
size of the output effects of such interventions lies in labor supply decisions.
Keywords: Multipliers, Redistribution, Labor supply, Idiosyncratic Risk. JEL Codes:
D90, E21, E25, E63
∗
We thank Ricardo Reis, Alisdair McKay, Jonathan Parker, Chris Carroll, Steve Williamson, seminar participants
at the 2014 Midwest Macro Meetings, ESM Summer Meetings, 3rd LuBraMacro, and City University of Hong Kong,
and Brown Bag participants at the Richmond Fed for helpful comments.
†
The views expressed are only those of the authors and do not reflect those of Federal Reserve Bank of Richmond
or the Federal Reserve System.
‡
Federal Reserve Bank of Richmond, kartik.athreya@rich.frb.org, 804-697-8225.
§
Federal Reserve Bank of Richmond.
¶
Federal Reserve Bank of Richmond.
1
1
Introduction
In the aftermath of the recent recession there have been numerous calls to use, as well as the actual
use of, transfers to low net-wealth households as a means to enhance economic activity.1 The
conventional argument for a positive effect of transfers from rich to poor on output centers on the
notion that wealth-poor households have a higher marginal propensity to consume out of wealth
than wealth-rich households, so that such a transfer leads to a boom in consumption. Under a
standard “Keynesian-cross” type intuition, this leads, in turn, to a boom in output. Such a view
puts household heterogeneity front and center in determining the aggregate short-run response to
a change in transfers. Therefore, any quantitative evaluation of the aggregate impact of wealth
redistribution requires the use of macroeconomic models capable of capturing such heterogeneity
in considerable detail.
Figure 1, below, shows the impact of a one-time surprise wealth redistribution from rich to
poor on aggregate output and consumption within the framework most widely used to understand
interactions between wealth inequality and the macroeconomy, the “standard incomplete-market
(SIM)” or “Bewley-Aiyagari-Huggett” model.2 Importantly, the version of the model we employ
incorporates nominal rigidities to allow aggregate demand to play a role. The parameters relevant
for the steady-state of the model are calibrated as in Castaneda et al., 2003, so that its initial
conditions match the extreme wealth concentration observed in the United States. Consistent with
the conventional argument, we see that a redistribution of wealth from rich to poor agents does
generate a consumption boom, and one that, furthermore, is prolonged.
What is also clear from Figure 1, however, is that wealth redistribution from rich to poor does
not result in an output boom. Given that our results arise from the benchmark model for analysis
of redistributive policies that, furthermore, matches salient heterogeneity along many dimensions,
they present a challenge to the conventional view that assigns short-run stimulative power to wealth
redistribution. The goal of this paper is to understand the driving forces behind the short-run effects
on consumption and output of wealth redistribution from rich to poor.
The main theme of our paper is that differences in marginal propensities to consume provide
incomplete input for the evaluation of the aggregate impact of wealth redistribution. This is because
these differences do not fully describe the differential impact of wealth transfers on labor supply.
For instance, if the marginal propensity to supply labor of wealth-poor households is no different
than that of wealth-rich households, aggregate labor supply will not change, all else equal.3 The
1
The most prominent redistributive policy implemented was the American Recovery and Reinvestment Act
(ARRA), which contained a significant redistributive component in the form of extensions of transfer programs
for the poor, such as unemployment insurance and food stamps (Oh and Reis, 2012). More generally, the idea that
the post-crisis evolution of the wealth distribution may be suppressing aggregate output in the recent recovery, is one
that has received attention. In particular, Mian and Sufi (2014) argue that, by increasing household net worth and
hence aggregate consumption, debt forgiveness may be a key for accelerating the recovery. See also Dynan, 2012, and
Cynamon and Fazzari, 2013.
2
Examples of papers using models within the same class to study wealth redistribution policies include Heathcote
(2005) and Conesa and Krueger (2006), among many others.
3
As a quantitative matter, a nontrivial effect of wealth on labor supply is highlighted in work by Floden (2001)
and Pijoan-Mas (2006).
2
Figure 1: Aggregate Impact of Wealth Redistribution
0.7
Output
Consumption
% Deviation from Steady State
0.6
0.5
0.4
0.3
0.2
0.1
0
−0.1
−0.2
−0.3
0
10
20
30
40
50
60
70
80
90
Years
fact that the results arise in the presence of nominal rigidities highlights that labor supply behavior
remains relevant even in general equilibrium models where aggregate demand can drive a wedge
between the marginal product of labor and the wage rate.
A key difficulty for the view that redistribution can boost output is that the same impulse that
leads wealth-poor households to consume proportionately more out of an additional dollar received
than their wealth-rich counterparts also pushes them to increase their leisure proportionately more.
Thus, barring countervailing forces, the same incentives that lead to a consumption boom also
induce a reduction in labor supply and, hence, output. We isolate particular assumptions concerning
preferences between consumption and leisure, as well as those concerning the tax system, that
mitigate this effect and, in particular instances, overturn it. In particular, aggregate labor supply
will tend to fall by less if, because of either preferences or the tax system, leisure is a “luxury”
in the sense that the rich spend proportionately more on it. In combination, those various effects
account for the fact that, while output does not rise in response to redistribution, it also does not
fall immediately. In addition, we examine the potential for general equilibrium channels to act as
countervailing forces, and we find that they can sometimes be relevant. The results highlight the
centrality of labor supply, in particular its wealth elasticity, in order to decisively sign and measure
the aggregate effect of redistributive policies.
The paper proceeds as follows. In Section 2, we present the baseline model. Section 3 presents
analytical results with respect to the neutrality of aggregate outcomes to wealth redistributions.
Sections 4 presents the quantitative results. Section 5 concludes.
Literature Review
Our work informs a growing quantitative literature examining the short-run aggregate effects of
wealth redistribution programs. Huntley and Michelangeli (2014) and Kaplan and Violante (2011)
aim to explain how wealth redistribution can lead to an increase in household consumption of the
3
size measured in empirical work (see Johnson et al., 2006; Parker et al., 2013; Japelli and Pistaferri,
2014; and Misra and Surico, 2014), though without focusing on the behavior of labor supply.
Heathcote (2005) studies the effect of a redistributive program in a heterogeneous-agent economy,
but assumes that the utility function is such that labor supply is unaffected by wealth. Heathcote
focuses instead on the distortionary impacts of the taxes needed to fund the transfer program. In
addition, Floden (2001), Pijoan-Mas (2006), Alonso-Ortiz and Rogerson (2010), Horvath and Nolan
(2013), and Zilberman and Berriel (2012) investigate the steady-state implications of redistributive
programs in heterogeneous-agent economies with endogenous labor supply.
In contrast to the work above, we focus entirely on the transitional dynamics of a redistribution policy that, by design, features no steady-state effects. Thus, our paper shares the emphasis
on business cycle frequency phenomena in Oh and Reis (2012), Reis and Mckay (2014), Mehrotra (2014), and Giambattista and Pennings (2014). The papers of both Mehrotra and Giambattista and Pennings analyze the effect of transfers in models with two types of agents, providing
assessments of transfer multiplier given different assumptions. Oh and Reis is the most closely related, as they analyze transitional dynamics following one-off redistributive policies in a full-fledged
heterogeneous-agent model. Their particular focus is on how wealth transfers ought to be targeted
in order to generate output booms. By contrast, our work analyzes the impact of policies that
redistribute wealth from rich to poor, as have been more typically advocated and implemented.
Lastly, our paper contributes by providing substantial analytical characterization of the effect
of various policies in a model where the heterogeneity across households is potentially very rich. In
existing work, analytical tractability is achieved through the use of special assumptions on income
processes, preferences, or market structures (see Heathcote, Storesletten, and Violante (2014) for
a recent contribution). As we will show, however, significant insight into the short-run effects of
redistribution can be attained without imposing any structure on shock processes beyond what is
necessary to deliver stationary aggregate outcomes.
2
Model
In what follows, we introduce a single model that nests a wide variety of Bewley-Aiyagari-Huggett
style environments including extensions that allow for nominal rigidities. For notational convenience, we denote all prices in terms of units of the final consumption good, inflating them by a
nominal price index whenever necessary.
2.1
Households
The economy is populated by a continuum of infinitely lived households with utility over consumption and leisure. Time is discrete and given that the short-run policy decisions that our paper
hopes to inform usually have annual horizons, a model period corresponds to one calendar year.
As high-frequency labor market frictions (arising, e.g., from search and matching or indivisibilities)
are likely to be relatively less important at annual frequencies, households are modeled as being
4
able to choose labor supply freely within a period.
Households differ in terms of their initial wealth and labor productivity. Labor productivity
for any given household changes stochastically and purely idiosyncratically, and households cannot
directly insure against those changes. Rather, households are constrained to holding only riskless
bonds. Furthermore, households are credit constrained in the sense that they cannot hold bonds
below a minimum threshold a, which is tighter than the natural borrowing limit.
Our focus throughout will be on a single, one-off, and wholly unanticipated wealth redistribution. This generates aggregate transition dynamics upon which prices depend that, after the shock,
are perfectly forecasted. We index the time since the shock by t, with t = 0 corresponding to the
aggregate steady-state and t = 1 the first date after the shock. For any given date t ≥ 1, the
problem of any given household can be written recursively as:
X
0
0 0
¯l − l + β
Vt (a, s) = max
u
c,
Pr
s
|s
V
a
,
s
t+1
0
s.t.
:
b ,c,l
0
a + c = y + a − τ (y) + πt + xt (a)
y = wt ε (s) l + rt a + ω (s)
a ≥ a, l ≥ 0
The notation is as follows: β < 1 is the discount factor, c is consumption; l is labor; ¯l is leisure endowment; u is an increasing, concave utility function that is differentiable in both its arguments; a
are initial asset holdings; a is an exogenous debt limit; s is the exogenous idiosyncratic productivity
state; ε (s) is the labor productivity of household in idiosyncratic state s with ε (1) = 1; wt is the
wage per effective unit of labor; rt is the interest rate on bonds; ω (s) are taxable government transfers; τ (y) are income taxes, with τ a (weakly) increasing function of yt ; πt are profits distributed
lump-sum to households, and xt (a) are tax exempt transfers or, if negative, non-tax-deductible
payments. As usual, primed variables refer to next period values, and Pr [s0 |s] is the probability of
transitioning into exogenous state s0 given that the household is in state s. Note that the pre-tax
transfer variable ω (s) is not time indexed, whereas the post-tax variable xt (a) is. This is because
the former is meant to capture permanent features of the tax code, whereas the latter will be the
source of the redistribution shock whose transitional impact we will analyze.
We denote by Γt (a, s) the joint density of households with asset level a and productivity level
s at the end of period t. We also denote the optimal choices of c, l, and a0 at each date t during
the transition by the policy functions ct (a, s), lt (a, s), and a0t (a, s). Letting S be the (finite) set of
exogenous state and A the (bounded closed interval) set of wealth levels, this allows us to define
aggregate consumption Ct , hours worked Lt , effective (productivity weighted) labor input Nt , endof-period household wealth At , pre-tax aggregate net transfers to households Ωt , and the post-tax
aggregate net transfers Xt respectively as follows:
5
Ct =
XZ
s∈S
Lt =
XZ
s∈S
Nt =
At =
Ωt =
Xt =
2.2
εt (s) lt (a, s) Γt−1 (a, s) da
(3)
a0t (a, s) Γt−1 (a, s) da
(4)
(ω (s) − τ (wt ε (s) lt (a, s) + rt a + ω (s))) Γt−1 (a, s) da
(5)
xt (a, s) Γt−1 (a, s) da
(6)
a∈A
XZ
s∈S
(2)
a∈A
XZ
s∈S
lt (a, s) Γt−1 (a, s) da
a∈A
XZ
s∈S
(1)
a∈A
XZ
s∈S
ct (a, s) Γt−1 (a, s) da
a∈A
a∈A
Firms
There are two types of firms: intermediate-goods producers and final-goods producers. Final goods
producers combine the intermediate goods and capital into a single final good that can be used
for consumption, investment in fixed capital, or government purchases. There is a unit mass of
differentiated intermediate goods producers indexed i ∈ [0, 1]. Each firm i is endowed with a linear
technology that allows it to transform one unit of effective labor that they use, ndt (i), into one unit
of intermediate good i that they produce, mt (i). Because intermediate goods are differentiated
across firms, their producers have market power and therefore can have some discretion over the
price that they charge pt (i). However, they are subject to nominal frictions, which limit their
ability to choose pt (i) in a timely manner. All intermediate-goods producing firms commit to
supplying the quantity mdt (i) that final-goods producers demand at the prevailing price, ensuring
that markets for all intermediate goods clear.
The production function for final-goods producers is:
Yt = F (Kt−1 , Mt ) ,
hR
i θ
θ−1
θ−1
1
where F is a neo-classical production function, Kt−1 is the capital stock, and Mt = 0 mdt (i) θ di
is an aggregate of different varieties of the intermediate good. Final-goods producing firms maximize profits, behave competitively, and use the funds they borrow from households to purchase
capital. The date t value of a final-goods firm (in terms of the final good), Ξt (Kt−1 ), that enters a
period with capital stock Kt−1 is then given recursively as follows:
Z
Ξt (Kt−1 ) = max F (Kt−1 , Mt ) −
Mt ,Kt
1
pt (i) mdt (i) di − Kt + (1 − δ) Kt−1 +
0
6
1
Ξt+1 (Kt )
1 + rt+1
hR
1
1−θ
i
1
1−θ
Let Pt ≡ 0 pt (i)
di
denote the per-unit price of the cost-minimizing bundle of intermediate
goods, and let δ denote the depreciation rate of capital.
The usual optimality conditions hold:
FK (Kt−1 , Mt ) = rt + δ
(7)
FM (Kt−1 , Mt ) = Pt
pt (i) −θ
d
mt (i) =
Mt ,
Pt
(8)
(9)
Let Qt be the nominal price level for the final good in the economy, so that pt (i) Qt is the
nominal price charged by firm i at time t. We assume that a fraction λ of the firms chooses pt (i) Qt
at the beginning of the period, after shocks have been realized, whereas the remaining 1 − λ chooses
nominal prices that they will receive in period t at the end of the previous period, t − 1. Thus,
a fraction 1 − λ sets prices before they have had time to incorporate period t information. Firms
distribute any profits πt (i) = (pt (i) − wt ) mt (i) to households.
To keep the model as comparable as possible to the benchmark competitive case, we assume
that intermediate goods producers receive a subsidy that is proportional to their output and are
simultaneously subject to a lump-sum tax to ensure that it is revenue neutral. Given the subsidy,
firms choose to set prices as close as possible to marginal cost. That is, they set
pt (i) Qt = wt Qt ,
if i belongs to the fraction λ of firms who set pt (i) Qt at the beginning of period t. If i instead
belongs to the fraction 1 − λ who set pt (i) Qt at the end of t − 1,we have that
pt (i) Qt = Et−1 [wt Qt ] ,
Note that if λ = 1, the model collapses to the standard competitive flexible price environment,
since in this case all firms price at marginal cost. Furthermore, in that case, Mt is equal to effective
labor supply Nt .
In steady-state there are no aggregate shocks, so all intermediate-good producing firms will have
had enough time to choose their prices optimally, and prices coincide with what would have been
set in the absence of nominal rigidities. At t = 1, a fraction 1 − λ sets p1 (i) Q1 = p0 (i) Q0 , whereas
the remaining adjust, setting p1 (i) Q1 = w1 Q1 . From t = 2 onwards, the economy proceeds as in
an environment without nominal rigidities since there are no more surprises.4
4
This approach to modelling nominal rigidities is similar to the one adopted by Oh and Reis (2012).
7
2.3
Government
Finally, the government taxes and transfers resources to households. It also consumes some of the
output. Government consumption has no utility advantage to households. Its budget constraint is:
Bt = (1 + rt ) Bt−1 + Gt + Tt
where Bt is government debt, Gt is government consumption, and Tt is net transfers. In equilibrium,
Tt is an aggregation of the transfers net of the taxes collected from all households and firms arising
from taxation rules (τ (y), ω (s), xt (a)). Government consumption Gt is chosen to implement a
particular pre-determined, nonexplosive, and perfectly forecasted path for government debt.
Monetary policy is as follows: In steady-state, the government achieves price stability so that
the price level is fixed at some level Q0 . While it seeks to achieve that price level in all periods, in
t = 1 it does not adjust its policy immediately, so that the nominal interest rate between period 1
Q2
is equal to its steady state level 1 + r0 . For t ≥ 2 onwards it is then able to set
and 2 (1 + r2 ) Q
1
Qt back to its steady-state target level Q0 .5
2.4
Equilibrium
∞
Equilibrium is given by sequence of prices {wt , rt , Qt }∞
t=0 , value functions {Vt (a, s) , Ξt (K)}t=0 ,
choices for intermediate-goods producers {mt (i) , pt (i) , πt (i)}∞
t=0 ∀i ∈ [0, 1], policy functions for
∞
0
households {ct (a, s) , lt (a, s) , at (a, s)}t=0 , intermediate-goods input choices for final goods produc
∞
ers mdt (i) t=0 ∀i ∈ [0, 1], aggregate variables {Ct , Lt , Nt , At , Ωt , Kt , Mt , Bt , Xt , Gt , Tt , πt }∞
t=0 , and
the joint density of assets and idiosyncratic shocks Γt (a, s) such that, given the path for transfer
policies {xt (a)}∞
t=0 , the policy functions, value functions, and sequences of Kt and Mt correspond
to the optimal choices of households and final-goods producers, the choices for intermediate-goods
producers are also optimal, the government follows fiscal and monetary policy rules as described in
Section 2.3 and:
1) Final-goods market clears:
Ct + Kt = F (Kt−1 , Nt ) + (1 − δ) Kt−1
2) Intermediate-goods markets clear:
mt (i) = mdt (i)
3) Labor market clears:
Z
1
ndt (i) di
Nt =
0
5
Such a monetary policy rule is employed in Krugman (1998) and Krugman and Eggertson (2012) among others.
In a wide range of sticky-price models, the government is able to implement policies of that kind even in a limiting
cash-less economy, given suitable out-of-equilibrium commitments on its part. See, for example, Woodford (2011).
8
4) Capital market clears:
Kt + Bt = At
5) Net transfers are Tt = Ωt + Xt
6) Profits from intermediate-goods producers are rebated to households:
Z
1
πt =
πt (i) di
0
7) For any interval [a1 , a2 ] ∈ A, the distribution of idiosyncratic states evolves as:
Z
a2
X
Γt+1 (a, s) da =
a1
Z
Pr [s|s̃] Pr [s̃]
a∈A0t (a1 ,a2 ,s̃)
s̃∈S
Γt (a, s̃) da
Where a ∈ A0t (a1 , a2 , s̃) if a0t (a, s̃) ∈ [a1 , a2 ].
2.5
Redistribution Experiment
We consider an experiment where at t = 0 the economy is in steady state, corresponding to the
state approximated by the economy when xt (a) = 0 ∀a for sufficiently long time. In the subsequent
period, t = 1, the after-tax transfer function changes from x0 (a) = 0 ∀a, to x1 (a) 6= 0 for some a.
From t = 2 onward, wealth taxes revert back to x0 (·), i.e., xt (a) = x0 (a) = 0 ∀a for t ≥ 2. We
furthermore impose that the redistribution be revenue neutral, that is,
XZ
s∈S
x1 (a) Γ0 (a, s) da = 0
a∈A
The surprise and one-off nature of the shock is designed to isolate the role of heterogeneity
on marginal propensities that lie at the heart of conventional intuition linking redistribution to
short-run aggregate outcomes. In particular, it prevents redistribution from affecting the return to
savings or labor effort directly. Thus, the presence or absence of aggregate effects of redistribution
are not driven by the distortionary effects of taxes on labor or capital, but by differences in marginal
propensities to consume and work out of wealth. This means that the policies we consider would
have no real effect whatsoever in an economy where households can be aggregated into a single
representative household. Furthermore, revenue neutrality allows us to isolate the role of wealth
redistribution across households in a moment in time from the role of government debt. The latter
has well-known real effects given the failure of Ricardian Equivalence in models of the class we
study. Thus, in our experiments, heterogeneity in the response of households to wealth transfers is
the sole underlying source of the dynamics.
9
3
Analytics
We now proceed to present a set of analytical results which lay out various forces determining
the initial impact to the equilibrium paths of an economy subjected to the one-off, unexpected
redistribution experiment described in Section 2.5. Our first proposition highlights the centrality
of labor supply in determining the general equilibrium impact of redistributive policies in a setting
without nominal rigidities. We then discuss the extent to which the proposition is helpful in
understanding environments with nominal rigidities.
3.1
Redistribution and Aggregate Expenditures
We start by examining the impact of a redistributive policy on aggregate expenditures, defined as
the sum of government consumption, household consumption, and gross fixed investment:
Et ≡ Gt + Ct + Kt − (1 − δ) Kt−1
Thus, Et corresponds to the NIPAs expenditure-side definition of GDP. We show that upon impact
aggregate expenditures depend fundamentally on aggregate labor supply. In particular, we show
that if aggregate labor supply remains unaffected by the wealth redistribution, then aggregate
expenditures do not change on impact, so that E1 = E0 , and neither do wages, so that w1 = w0 .
Consider the household budget constraint at t = 1, with the choice variables already substituted
for the corresponding policy functions.
a01 (a, s)+c1 (a, s) = w1 ε (s) l1 (a, s; w1 )+(1 + r1 ) a+ω1 (s)−τ (w0 ε (s) l1 (a, s; w1 ) + r1 a + ω (s))+x1 +π1
where we make it explicit that the policy function for labor supply l1 (·) depends, among other
things, on current wages. Changes in the function over time thus represent changes in labor supply
induced by different paths for the interest rate and future wages.
Integrate across all households and apply the definitions (1) through (6) to get:
A1 + C1 = w1 N1 (w1 ) + (1 + r1 ) A0 + Ω1 + X1 + π1 ,
where, consistent with the change in notation above, we now make explicit the dependence of
aggregate labor supply, N1 , on current wages. Note that the government budget constraint implies
that X1 + Ω1 = −G1 + B1 − (1 + r) B0 , and in equilibrium A1 = K1 + B1 . Thus, with some
rearranging,
K1 + C1 + G1 = w1 N1 (w1 ) + (1 + r1 ) K0 + π1 .
We thus obtain the national accounting identity equalizing final expenditures with gross income:
E1 = w1 N1 (w1 ) + (r1 + δ) K0 + π1 .
10
3.1.1
No Nominal Rigidities
Absent nominal rigidities, λ = 1, all intermediate-goods producers choose the same price p1 (i) = w1
hR
i 1
1−θ
1
(recall that the subsidy keeps them from charging a markup), so that P1 = 0 p1 (i)1−θ di
=
w1 . It thus follows from the first order condition for the final-goods producer (8) that w1 =
hR
i θ
θ−1
θ−1
1
FM (M1 , K0 ). Also, it is the case that M1 = 0 m1 (i) θ di
= N1 and therefore we can substitute M1 for N1 (w1 ) in the production function so that, in equilibrium, r1 = FK (N1 (w1 ) , K0 )−δ
and π1 = 0. Thus, equilibrium aggregate expenditures are, upon impact,
E1 = FM (N1 (w1 ) , K0 ) N1 (w1 ) + FK (N1 (w1 ) , K0 ) K0 .
(10)
Aggregate expenditures are, therefore, entirely determined by equilibrium labor supply N1 (w1 ) and
pre-determined variables. We can verify that, if N1 (w0 ) = N0 (w0 ), then there is an equilibrium
with w1 = w0 and hence E1 = E0 . To see that, suppose the equilibrium features w1 = w0 . Then,
in that case, w1 = FM (N1 (w0 ) , K0 ) = FM (N0 (w0 ) , K0 ) = w0 .
We state the result above in the following proposition:6
Proposition 1 Consider the impact of a one-off and completely unexpected wealth redistribution.
Suppose λ = 1, and the equilibrium reaction is such that aggregate labor supply does not change
on impact (N1 (w0 ) = N0 (w0 )). Then, if the equilibrium is unique, aggregate expenditures do not
change on impact (E1 = E0 ) and neither does the wage rate (w1 = w0 ).
Proposition 1 provides an important benchmark, since, as we later discuss, some commonly
used assumptions about preferences and/or production opportunities yield constant labor supply
as an equilibrium outcome. The proposition is significant because it shows in very stark terms the
limitations of focusing on the behavior of consumption in order to understand the short-run effects
of redistributive policies in the class of environments without nominal rigidities. This is because
it does not require any assumption about the equilibrium behavior of consumption. In particular,
in a setup without nominal frictions, knowledge about the distribution of marginal propensities to
consume out of wealth is completely uninformative about the aggregate impact of the redistribution.
Also, the lack of short-run reaction of output and labor input to the redistribution is true even
though the equilibrium interest rate r2 can potentially change significantly.
The proposition also implies that, absent a labor supply effect, any boom in consumption engineered by a redistributive policies translates itself into a reduction in other components of aggregate
expenditures. This means that, absent compensating reductions in government expenditures, a redistributive policy that leads to a boom in consumption will also lead to a reduction in investment
and the capital stock, thus having negative effects on aggregate output in subsequent periods.
6
The proposition generalizes Proposition 2 in Mehrotra (2012). The key differences are that we do not require
the labor supply function to depend only on current wages,.and that our proposition applies to economies with more
than two types of agents.
11
3.1.2
Nominal Rigidities
With nominal rigidities, Proposition 1 does not hold in general. This is for two reasons. First, with
nominal rigidities, profits distributed to households are not always zero. As a result, we have,
E1 = w1 N1 (w1 ) + (δ + r1 ) K0 + π1 .
Even if N1 (w0 ) = N0 (w0 ), w1 = w0 and r1 = r0 , then expenditures can still change so long as
profits change. Such a change can occur for example due to changes in nominal variables, which
drive a wedge between the price planned by intermediate goods producers and their marginal cost.
Second, since wages can be different from the marginal product of labor, constant aggregate
labor supply does not guarantee that equilibrium wages remain constant. Therefore, an equilibrium
in which current wages and, therefore, labor supply respond on impact is entirely possible.
Nevertheless, we can construct an example where, given the monetary policy rule described in
Section 2.3, the equilibrium with nominal rigidities is identical to the one without. The example
consists of an economy where the marginal products of capital and the composite intermediate
input to final goods production are invariant to quantities. In this case, FK (K0 , M1 ) = fk and
FM (K0 , M1 ) = fM , where fK and fM are constants. As a result, the real interest rate is fixed at
rt = fK −δ and the real price index for intermediate inputs is fixed at Pt = fM . From the monetary
policy rule we have that:
1 + r0 = (1 + r2 )
Q2
,
Q1
which, substituting in r0 = r1 = fK − δ and for Q2 = Q0 given by the fact that the policy rule
takes the price level back to its steady-state level after t = 1, yields
(1 − δ + fK ) = (1 − δ + fK )
Q0
,
Q1
so that
Q0 = Q1 .
From the definition of the price index for materials,
Z
P1 =
1
1−θ
p (i)
1
1−θ
di
0
Z
=
1
λ
0
pf1 lex
1−θ
+ (1 − λ)
pf1 ix
1−θ
1
1−θ
di
where pf1 lex is the price set by firms not subject to nominal rigidities and pf1 ix is the price of those
subject to nominal rigidities. As discussed above, in steady-state all firms set their price equal to
their marginal cost (recall that we allow for subsidies in order to abstract from distortions induced
12
by monopoly), so that nominal price set by firms subject to nominal rigidities is w0 Q0 and their
0
price in terms of final goods pf1 ix = w0 Q
Q1 . Flexible price firms set price equal to marginal cost w1 .
Substituting back into the definition of the price of materials as well as P1 = fM , yields
"Z
1
λw11−θ
fM =
0
Q0
+ (1 − λ) w0
Q1
1−θ !
#
1
1−θ
di
,
which, since Q0 = Q1 , yields
Z
fM =
0
1
λw11−θ
1−θ
+ (1 − λ) (w0 )
1
1−θ
di
,
(11)
It is also immediate to verify that w0 = fM , since FM (K0 , M0 ) = fM and pf0 ix = pf0 lex = w0 .
Furthermore, rearranging equation (11) for w1 , and taking into account that w0 = fM , we find
that w1 = fM . Hence, w1 = w0 . Finally, profits for firm i are π1 (i) = (p1 (i) − w1 ) m1 (i). Since
p1 (i) = w1 = w0 for all i, π1 (i) = 0 for all i, and πt = 0. Thus, equation (10) holds. It is also
straightforward to verify that wt = fM and rt = fK for all values of t.
More generally, given that real wages and real interest rates are exactly the same irrespective of
the degree of nominal rigidities, household decisions are also identical and, thus, are all equilibrium
objects. We summarize these observations in Proposition 2 below:
Proposition 2 Consider the impact of a wealth redistribution program that is one-off and completely unexpected. Suppose FK (K, M ) = fK and FM (K, M ) = fM . Then the allocation does not
depend on λ. In particular, if the equilibrium reaction is such that aggregate labor supply does not
change on impact (N1 (w0 ) = N0 (w0 )) and if the equilibrium is unique, aggregate expenditures do
not change on impact (E1 = E0 ) and neither does the wage rate (w1 = w0 )
Proposition 2 is quantitatively relevant because the short-run impact of the redistributive policy
on the capital stock and, hence, on its marginal product, is likely to be very small. This is because
investment is only a small fraction of the total capital stock. If, moreover, the investment technology
is approximately linear in investment, then interest rates will react minimally to any reasonably
sized redistribution. Therefore, in order for nominal rigidities to have quantitative impact, one
needs to allow for investment adjustment costs. In the quantitative section 4, we capture similar
effects in a variant of the main quantitative exercise depicted in Figure 1 by increasing the degree
of concavity for capital in the production function.
3.2
Redistribution and Aggregate Labor Supply
Given the importance of aggregate labor supply movements highlighted in Section 3.1, we now
examine more closely how wealth redistribution affects labor supply decisions. In particular, we
examine which assumptions change aggregate labor supply, as well as the direction of the implied
changes. As we will show, a key driving force is how marginal propensities to work correlate with
13
wealth across the population. We locate conditions under which these correlations are positive,
negative, or zero.
For the analysis that follows, it is convenient to separate intra-temporal decisions made by
households over consumption and leisure from intertemporal decisions over wealth accumulation.
We therefore start by defining z to be the sum of the household’s expenditures on goods and leisure.
Thus,
z ≡ c + wε (s) ¯l − l .
For most of this section, we examine first the case where there is no distortionary income tax,
i.e., where τ (y) = 0 for all y. Later in this subsection, we return to the case with distortionary
taxation in order to examine its role. Without taxes, the problem of the household can be written
as
Vt (a, s) = max
ũ (z; wt , s) + β
0
s.t.
:
b ,c,l
0
X
Pr s0 |s Vt+1 a0 , s0
a + z = wt ε (s) ¯l + (1 + rt ) a + ω (s) + πt ,
a ≥ a,
with ũ (·) the value function obtained from the within-period problem
ũ (z; w, s) = max u c, ¯l − l
c,l
s.t.
:
c + wε (s) ¯l − l = z.
In addition to the usual policy and value functions, the problem above also yields the policy
function for z, zt (a, s). Aggregate expanded consumption expenditures therefore are given as:
Zt =
XZ
s∈S
zt (a, s) Γt−1 (a, s) da
a∈A
Finally, we can write policy functions for consumption and hours coming from static sub-problem
as:
c = cstatic (z, s, w)
l = lstatic (z, s, w)
Naturally, it is the case that ct (a, s) = cstatic (zt (a, s) , s, w) and lt (a, s) = lstatic (zt (a, s) , s, w).
The alternative, static, policy functions are useful in that they clarify that the choice of consumption
and labor supply only depend on the aggregate state through wages wt and through whatever its
14
impact is on the choice of expanded consumption expenditures z.
3.2.1
No Wealth Effects on Labor Supply
One immediate implication from the decomposition above is that labor supply can only change
in response to a redistribution if lstatic (z, s, w) depends on expanded consumption z. It then
follows immediately from Proposition 1 that wealth redistribution upon impact keeps labor supply
unchanged. The leading case where lstatic (z, s, w) does not depend on z is under preferences
postulated by Greenwood et al. (1988). Under those preferences,
u c, ¯l − l = h c + g ¯l − l
where h is increasing and concave. At any t, the optimality condition for labor supply in the static
problem satisfies
g 0 ¯l − ltstatic (z, s; w) = ε (s) w,
so labor supply depends, at the individual level, only on the current effective wage rate ε (s) w.
Thus,
N0 (w0 ) = N1 (w0 ) =
X
ε (s) ¯l − g 0−1 (ε (s) w0 ) Γs0 (s)
s∈S
where Γs0 (s) is the marginal distribution of exogenous idiosyncratic productivity states s at time
0. Therefore, in this case, we have that N1 (w) = N0 (w) for all w and, in particular, for w = w0 .
The result highlights the essentiality of wealth effects on labor supply in determining the aggregate
short-run impact of wealth redistribution.
3.2.2
Wealth Effects on Labor Supply
We now examine the effect of redistribution in the presence of wealth effects on labor supply. We
start with the benchmark case of Cobb-Douglas utility within periods, and then we proceed to
examine more general cases.
Cobb-Douglas Utility We will define a utility function to be “Cobb-Douglas within the period ”
if it is of the form
µ
u c, ¯l − l = h c1−µ ¯l − l
,
where h is an increasing and strictly concave function. The utility function is, of course, fairly standard. In particular, it is widely used in the business cycle literature, as some of its particular cases
are compatible with a balanced growth-path for the economy. Also, it is featured in heterogeneous
agent models such as Krusell and Smith (1998).
15
Given Cobb-Douglas preferences, we have that expenditures on consumption and leisure are a
constant fraction of z, so that:
cstatic (z, s; w) = (1 − µ) z,
µ
lstatic (z, s; w) = ¯l −
z.
wε (s)
Thus, for a given wage, any shock that leads a household to increase its consumption will
also lead it to decrease its labor supply. More generally, any change in the environment that
leads households to reduce savings (and, therefore, increase z), will also induce them to increase
consumption and reduce labor supply.
This same logic translates to aggregate quantities. To see this, first integrate wt ε (s) ¯l − lt (a, s) =
µzt (a, s) across households to get
Zt
,
wt
= (1 − µ) Zt
Nt = N̄ − µ
(12)
Ct
(13)
P
where N̄ ≡ ¯l s∈S Γs0 (s) ε (s). Thus, given the wage rate, labor supply is decreasing in the amount
of wealth allocated for current period consumption. Second, aggregating household budget constraints yields the following relationship between aggregate savings At and aggregate expanded
consumption Zt :
At = wt N̄ + (1 + rt ) At−1 − Zt .
It follows that effective hours worked are increasing in aggregate savings. Hence, any change in the
economic environment that leads to a reduction in aggregate savings, will, for a given wage, lead
at the same time to an increase in aggregate consumption and a reduction in aggregate effective
hours worked.
In particular, if prices are fully flexible, and aggregate savings do not change (for example
because asset supply is fixed, as in Guerrieri and Lorenzoni (2012), or adjustment costs to capital are
extremely large), Proposition 1 holds, and neither aggregate labor supply, aggregate consumption,
nor aggregate expenditures change. More generally, given decreasing returns to labor input, under
price flexibility any redistribution that increases aggregate consumption Ct , will also reduce effective
labor supply. To see this, recall that with flexible prices, wages satisfy wt = FM (Nt , Kt−1 ) (since
Mt = Nt ) so that, holding K0 fixed, w1 is decreasing in N1 . Substituting out Zt from the expression
for aggregate labor supply (12), we have that
16
µ C1
1 − µ w1
µ
C1
= N̄ −
1 − µ FM (N1 , K0 )
N1 = N̄ −
This induces an implicit function of N1 on C1 with derivative given by the implicit function theorem:
µ
1
dN1
1−µ FM (N1 ,K0 )
=−
dC1
1 − µ C1 FM M (N1 ,K20 )
1−µ (FM (N1 ,K0 ))
Thus, given that F (M1 , K0 ) is neo-classical (so that FM M (M1 , K0 ) ≤ 0),any increase in C1 leads
to a reduction in N1 .
We state the result in the following Proposition:
1−κ
Proposition 3 If λ = 1, Z1 = Z0 , u c, ¯l − l = h cκ ¯l − l
, and there are no taxes and
transfers, then w1 = w0 , N1 = N0 , and C1 = C0 . If Z1 > Z0 , then C1 > C0 and N1 < N0 , with the
inequalities reversed if Z1 < Z0 .
Note that with Cobb-Douglas preferences, it is not necessarily the case that wealthier households
consume more leisure, since what is being kept constant are expenditures in leisure as a fraction
of wealth. If wealthier households are also more productive (so that ε (s) is higher), they can
conceivable supply much more labor time than less wealthy households. The reason effective labor
supply stays constant is that aggregate effective hours worked is the sum of individual labor supply
weighted by productivity ε (s).
Proposition 3 implies that Cobb-Douglas preferences yield a particular kind of aggregation in
consumption and labor-supply decisions. A natural question then is: How stringent is the CobbDouglas requirement? In classical demand theory, homothetic preferences are typically sufficient
to allow for aggregation of household choices, meaning that wealth redistribution does not change
outcomes. The reason this is not sufficient in the current setting is because different households
face effectively different wages. If the elasticity of substitution between consumption and leisure
is not equal to 1, this implies that high-productivity households consume a different share of their
expanded consumption, z, than low-productivity households, so that redistribution between them
will have an impact on aggregate effective labor supply.
Small Redistributions with General Preferences We now turn to the impact of redistributive policies for general preferences. While all preceding results hold for any wealth redistribution,
we now focus on redistributions that transfer from the wealthy to the poor, that is, that feature
an x1 (a) that is monotonically decreasing in a. In general, the impact of the redistribution on
effective labor supply is
N1 − N0 =
XZ
s∈S
(ε (s) (l1 (a, s) − l0 (a, s))) Γ (a, s) da
a∈A
17
In the case of small redistribution policies, we can clearly separate the various competing ways
in which wealth redistribution can affect labor supply. Restricting attention to policy functions that
are differentiable with respect to all states and prices, and defining “small”
redistributions to be
(a,s) x(a)
x1 (a)
those for which we can approximate the policy function φt a + 1+r1 , s by φt (a, s) + ∂φt∂a
1+rt ,
we have that
x1 (a)
ε (s) l
z0 a +
, s , s; w0 − ε (s) lstatic (z0 (a, s) , s; w0 )
1+r
x1 (a) ∂z0 (a, s) ∂ε (s) lstatic (z (a, s) , s, w0 )
∼
.
=
1+r
∂a
∂z
{z
}
| {z 1}| {z }|
static
(+/-)
(+)
(14)
(-)
with the signs in brackets indicating the direction of change in the corresponding terms. The
expression above denotes the change in labor supply for a given household, holding prices fixed,
and allowing only its wealth to change. It therefore captures the partial equilibrium component of
a household’s reaction. We denote the expression in equation (14) by P1 (a, s)
The expression 14 has three components. The first one is the wealth transfer itself, normalized
by the interest rate, so that it is in the same units as beginning-of-period assets. Given revenue
neutrality, x1 (a) is positive for very wealthy households and negative for less wealthy ones. Together, the two last terms give the household’s marginal propensity to work out of financial wealth.
(a,s)
The term ∂z0∂a
denotes the effect of increased wealth on “expanded consumption” z. This is, of
course, inversely related to the marginal propensity to save out of wealth. It is positive if both consumption and leisure are normal goods, since an increase in wealth relaxes the intertemporal budget
constraint of the household. The final component is the static wealth effect on effective labor supply. Overall, the partial equilibrium component is negative for households that are on the receiving
side of the redistribution policy and positive for the households that are on the contributing side.
Price changes affect labor supply directly, through current wages w1 , and indirectly, through
the function z0 (a, s), which, given other price changes, becomes z1 (a, s). The general equilibrium
component can therefore be written as
ε (s) lstatic (z1 (a, s) , s; w1 ) − ε (s) lstatic (z0 (a, s) , s; w0 )
∞
X
∂z0 (a, s)
∂ε (s) lstatic (z0 (a, s) , s, w1 )
∂z0 (a, s)
∼
drv +
dwv
=
∂rv
∂wv
∂z
v=1
+
∂ε (s) lstatic (z0 (a, s) , s, w1 )
dw1 .
∂w1
(15)
The component in parenthesis summarizes whose savings decisions the path of prices over time
affects. Those changes multiply the static wealth effect on labor supply. Additionally, current wages
exert direct influence on labor supply for any given level of savings. We denote the expression in
equation (15) by G1 (a, s). Collecting all terms, it follows that, to a first order approximation, the
18
change in effective labor following a redistribution can be denoted by
N1 − N0 ∼
=
XZ
s∈S
(P1 (a, s) + G1 (a, s)) Γ (a, s) da.
a∈A
We will from this point onward focus our analysis on the determinants of the partial equilibrium
R
P
component s∈S a∈A P1 (a, s) Γ (a, s) da. This ought to be informative about the overall impact
of redistribution on labor input so long as the term is large relative to the general equilibrium
component. Furthermore, in the quantitative analysis in Section 4 we verify that the intuitions
derived from this analysis remain intact.
Before proceeding, we state a proposition linking the shape of the marginal propensity to work
(a,s) ∂ε(s)lstatic (z(a,s),s,w0 )
out of wealth ∂z0∂a
to the partial equilibrium component of the change in N .
∂z
Let Γ0 (s|a) denote the proportion of households with exogenous productivity s given wealth a.
Then, the following proposition holds:
Proposition 4 Given a “small” wealth redistribution with x1 (a) decreasing in a, the partial equilibR
P
rium component of its impact on aggregate effective labor supply is given by s∈S a∈A P1 (a, s) Γ (a, s) da.
P
(a,s) ∂ε(s)lstatic (z(a,s),s,w0 )
Γ0 (s|a) is increasing in a.
This component is positive if s∈S ∂z0∂a
∂z
The proposition states that the partial equilibrium component of a redistribution is positive if
the labor supply of high-wealth households is more sensitive to their wealth. Intuitively, if this is the
case, high-wealth households will increase their effective labor supply more in response to a dollar
lost than a low-wealth household will reduce theirs in response to that same dollar received. This
is the analogue to the conventional intuition about how heterogeneity in marginal propensities to
consume influence the aggregate consumption response to redistribution. Note that if wealth effects
on labor supply are always zero, as in Greenwood-Hercowtiz-Huffman preferences, then the partial
equilibrium component is also zero. We now proceed to discuss each of the terms determining the
marginal propensity to work separately.
Intertemporal Determinants of Aggregate Labor Supply The first component deter(a,s)
, denotes how wealth affects the intertemporal
mining the marginal propensity to work, ∂z0∂a
choices made by the household. This is because, given the budget constraint, this term is symmet∂a0 (a,s)
(a,s)
ric to the change in wealth accumulation decision, so that ∂z0∂a
= 1 + r1 − 0∂a . Therefore,
∂z0 (a,s)
is increasing in a if the policy function for asset accumulation is concave in a.
∂a
The literature on incomplete market models points to a strong presumption that a00 (a, s) ought
(a,s)
to be convex, so that ∂z0∂a
is decreasing in a. The reason, emphasized by Gourinchas and Parker
(2002) is that wealth-poor households engage in buffer-stock savings behavior, going through a lot
of effort to save to self-insure against income risk. As they grow wealthier, they are able to selfinsure without having to consume so little and work so hard, so they increase their expenditures
and reduce their hours worked very quickly. For very wealthy households, marginal changes in
their wealth do not affect their ability to self-insure. Thus, their main reason for saving is for
intertemporal smoothing, saving more out of a given dollar received. To the extent that this logic
19
carries through to a world with two goods (consumption and leisure), this implies that wealthy
households will not change their consumption and labor supply much in response to a one-off,
temporary change in their wealth. Thus, redistribution from wealth-rich to wealth-poor households
is likely to lead to a boom in aggregate consumption and a drop in aggregate effective labor supply.
Given the consensus in the literature that a00 (a, s) is convex, proposition (4) suggests that
wealth redistributions can very plausibly lead to a boom in consumption at the same time as
they lead to a drop in effective hours worked. One case where this holds is when preferences
are Cobb-Douglas and there are no income taxes.7 In that case, the intratemporal component
∂ε(s)lstatic (z(a,s),s,w0 )
= − wµ0 , so that it does not vary across households, and the partial equilibrium
∂z
(a,s)
component of the change in labor supply is entirely determined by the shape of ∂z0∂a
. We now
turn to a more detailed discussion of which features of preferences and the tax-code determine the
static (z(a,s),s,w )
0
variation ∂ε(s)l
.
∂z
Intratemporal Determinants of Aggregate Labor Supply The second component de∂lstatic (z,s;w)
, denotes how changes in the amount of
termining the marginal propensity to work, 0 ∂z
resources dedicated to current period expenditures, and hence to savings, affect labor supply. It,
therefore, relates to the intra-temporal decision that households make about how to allocate these
resources between consumption and leisure. Such intra-temporal considerations are important
since, in typical calibrations, intra-temporal preferences between consumption and leisure do not
satisfy homotheticity. Notably, Pijoan-Mas (2006) has emphasized the fact that departure from
homotheticity is necessary to explain the low observed cross-sectional correlation between wages
and hours. A similar departure is present in the calibration used by Castaneda et al. (2003) and
for the experiment in Figure 1.
∂ε(s)l0static (z,s;w)
in terms of the share of expenditures dedicated
We characterize the shape of
∂z
static
wε(s)(l̄−l
(z;s,wt ))
to leisure, µ (z; s, w) =
. This allows us to connect the cross-sectional variation
z
in the static component of labor supply to classical demand theory, which emphasizes the role of
variation of expenditure shares with wealth. We focus on cases in which µ is twice differentiable in
z and denote by µz (z; s, w) and µzz (z; s, w) the first and second derivatives with respect to z. We
have that:
Proposition 5 Consider the partial equilibrium component of the impact of a wealth redistribution
∂ε(s)l0static (z,s;w)
x1 (a), with x decreasing in a. Then
increases with z if µz (z; s, wt ) > 0 and
∂z
µzz (z;s,wt )z
µzz (z;s,wt )z
µz (z;s,wt ) > −2 and it decreases with z if µz (z; s, wt ) < 0 and |µz (z;s,wt )| < 2.
The proposition states that redistribution increases labor supply if leisure is a luxury good in
the intratemporal problem, i.e., if households spend an increasing fraction of their “expanded”
expenditures with leisure rather than consumption goods as expanded expenditures increase. The
bounds on the curvature of the share function µ (z; s, w) ensure that the intensity with which
households of different wealth levels spend on leisure does not change too quickly with their wealth.
7
This also holds for proportional income taxes. See Lemma 1.
20
It is important to notice that the luxury nature of a good is tied to the amount spent for given
prices. Thus, it is entirely consistent with leisure being a luxury good that a wealthier household
consumes less leisure than a less wealthy one, so long as they face different wages (since they have
different productivities).
The following corollary shows the proposition applies to the commonly used case of separable
utility:
Corollary 1 Suppose the utility function is:
1−σL
u c, ¯l − l = c1−σC + φ ¯l − l
with σc > 0, σl > 0, and φ > 0. Then,
otherwise.
∂ε(s)l0static (z,s;w)
∂z
increases with z if σL < σC and decreases
Thus, wealth transfers have a stimulative effect so long as the intertemporal elasticity of substitution for leisure ( σ1L ) is larger than for consumption ( σ1C ). In the intratemporal problem of the
household, this implies that leisure is a luxury good and consumption is a necessity. This relation
between σL and σC is exactly the one that Pijoan-Mas (2006) has argued for.
The conditions for the propositions above appear to hinge on properties of households’ underlying preferences. However, it is important to note that, subject to mild regularity conditions,
the tax code can induce households to behave as if leisure were a luxury good even if underlying
preferences are Cobb-Douglas. More formally, the following Lemma holds:
1−κ
Lemma 1 Suppose taxes are progressive, so that τ 00 (y) > 0 and u c, ¯l − l = h cκ ¯l − l
,
with h increasing and concave. Suppose furthermore that wealth effects on labor supply are mild
wε(s)(l̄−l)
increases with z.
enough that ra + wε (s) l0 (a, s) is increasing in a. Then the ratio
z
Thus progressive taxation can be a further factor leading to a more positive impact of redistributive policies.
3.2.3
Indivisible Labor
We have thus far focused on cases in which labor supply can be smoothly varied. At higher than
annual frequencies households might be unable to adjust labor in such a smooth fashion. Therefore,
we conclude the analytical section by examining the short-run effect of wealth redistribution when
labor supply is indivisible. The extension of the heterogeneous agent model for this case has been
examined by Alonso-Ortiz and Rogerson (2010) among others. In particular, Alonso-Ortiz and
Rogerson (2010) show that labor supply functions are characterized by a threshold rule, such that
for each exogenous productivity level, there is a cutoff level of wealth, a(s), such that labor supply
is zero if wealth exceeds the threshold and maximal otherwise. The proposition below characterizes
the partial equilibrium response of such an economy to a wealth redistribution.
21
Proposition 6 Consider a “small” redistributive policy x1 (a), with x decreasing in a. Suppose
labor supply decisions are characterized by a threshold ā (s) so that l (a, s) = 0 if a > ā (s) and
l (a, s) = ¯l if a ≤ ā (s). Then, the partial equilibrium component of the change in effective labor
supply is positive if and only if
X
ε (s) x (ā (s)) Γ (ā (s) , s) > 0.
s∈S
Therefore, output increases if the workers at threshold points are, on average, net contributors
to the redistribution, where the average is weighted by how much they receive and by their labor
productivities. The result highlights that the direction of the impact of redistribution on output is
highly sensitive to the details of the program and of the joint distribution of wealth and productivity.
4
Quantitative Analysis
Our analytical results highlight that the short-run effect of a wealth redistribution depends fundamentally on the specific factors that influence labor supply decisions, including properties of
household savings behavior. Therefore, the sign and size of the overall impact can only be resolved
with the use of a quantitative model. Given our focus on the short-run reaction of the economy
to a one-off redistributive shock, it is essential that the initial state accurately captures observed
wealth heterogeneity in the U.S. economy. We therefore employ a baseline incomplete markets
model that is specifically calibrated to match the wealth distribution in the United States along
several dimensions, including the extreme concentration in its right tail.
4.1
Parameterization
With the exception of the parameters we specify in this section, we follow the parameterization of
Castaneda et al. (2003), since more standard parameterizations, e.g. Aiyagari (1994), normally
miss the concentration present in the right tail of the distribution. Two salient features of that
parameterization are as follows: First, the authors specify a labor productivity process designed to
capture life-cycle movements in income. As such they include “retirement” and “rebirth” shocks,
the first of which turns the labor productivity of households to zero while the second one restores
it to a positive value. Second, in order to capture the extreme concentration of wealth in the U.S.
economy, Castaneda et al. (2003) employ an extremely high and brief productivity state, which is
reached with very low probability.
We adopt a yearly calibration of the model. Outcomes at annual frequencies are likely to be
the relevant ones for macroeconomic policymakers, as opposed to monthly or quarterly frequencies.
Moreover, because households are more likely to have discretion over hours worked over the course
of a year than over the course of a month or a quarter, flexible labor supply is the appropriate
assumption. This, in turn, confers the tractability that we exploit to derive analytics.
Since Castaneda et al. (2003) examine steady states in which nominal rigidities are irrelevant,
22
we need to select parameters for the nominal frictions. We examine two cases: one with λ = 1,
corresponding to the benchmark without nominal rigidities and one with λ < 1. For the second
case, we chose λ = 0.5, so that half of the firms change prices in a given year. Given that one
period corresponds to a year, this is in line with the evidence in Bils and Klenow (2004) that firms
take on average close to half a year to change their prices. We also set the elasticity of substitution
between different varieties of intermediate goods θ = 10, as suggested by Woodford (2003).
In the baseline case, the production side of the economy is a Cobb-Douglas production function
for final goods production. As we will see, in that case there is very little quantitative short-run
impact on the interest rate. To understand the effects of changes in interest rate upon equilibrium,
we also investigate a variant of the model in which we augment the production function with
a quadratic term − 21 (Kt − K0 )2 , so that interest rates become more sensitive to changes in the
capital stock.8
The wealth transfer at the center of our analysis is structured to move wealth, a, from richer to
poorer households and takes the functional form: x(a) ≡ η − χa, with η and χ < 1. This function
gives the net change in wealth after the transfer. We will consider a tax of 2 percent, i.e. set
χ = 0.02, and set η so that the transfer is revenue neutral.
5
Description of the Initial Conditions
We now describe the initial state of the economy immediately following redistribution but prior
to agents having time to react. It is this initial condition that determines the short-run aggregate
impacts. The first column in Table 1 shows the average change in wealth implied by the policy
for different wealth quantiles. The average change in wealth is positive for the first four quintiles.
Indeed, 75.16 percent of the households are net recipients of wealth transfers. Consistent with the
very skewed wealth distribution in the data, we find that the wealth paid out by a single household
in the upper wealth percentile funds transfers to approximately 50 households in the three lowest
quintiles.
Table 1 also collects, for different wealth quantiles, the conditional means of (1) the change
0 (a,s)
− 1,
in wealth, referred to above (x1 (a)), (2) the marginal propensity to save, defined as ∂a ∂a
∂c(a,s)
and denoted by MPS, (3) the marginal propensity to consume out of wealth, defined as ∂a and
denoted by MPC, and (4) the marginal propensity to supply hours defined as ∂l(a,s)
and denoted
∂a
by MPL. This definition of marginal propensity to save (MPS) adjusts for the fact that, absent a
behavioral response, households would mechanically increase their wealth by the amount that they
receive. The second column shows clearly that the mean marginal propensity to save rises with
wealth. It is a symptom of low wealth pushing households to work more and consume less in order
to build up precautionary balances. Thus, the shape of the policy function for savings conforms
to the general finding in the literature, discussed in Section 3.2.2. If marginal propensity to save
8
In that case, the production function exhibits decreasing returns to scale, so that final-goods producers earn
economic profits. We assume that those profits are taxed lump-sum by the government and used to finance government
expenditures.
23
increases with wealth, then the marginal propensity to consume decreases with wealth. At the same
time, the marginal propensity to work becomes less negative across all wealth quantiles, except the
first. It should be noted, that, given Castaneda et al.’s (2003) calibration, the first wealth quintile
includes a large fraction of retirees, for whom labor supply is perfectly inelastic.
Table 1: Average Wealth Transfer and Marginal Propensities, by Wealth Quantile
Wealth Quantiles
First
Second
Third
Fourth
Fifth
5.1
Quintile
Quintile
Quintile
Quintile
Quintile
90-95
95-99
99-100
x1 (a)
MPS
MPC
MPL
0.2195
0.2107
0.2036
0.0642
-0.699
-0.5237
-0.7229
-11.029
-0.6409
-0.1934
-0.1717
-0.0911
-0.0884
-0.0855
-0.1221
-0.0393
0.6399
0.0914
0.0898
0.057
0.0438
0.0466
0.0355
0.0602
-0.0571
-0.1749
-0.1497
-0.0555
-0.0199
-0.012
-0.0173
-5.25E-04
Results
We now turn to the quantitative results. The state of the economy at any given point in time is given
by the joint distribution of productivity and wealth. One summary of the state is wealth inequality.
Figure 2 shows how inequality, as measured the Gini coefficient, evolves over the transition. We
see that upon impact inequality falls by 2 percent. However, as the transition continues, we see
that inequality monotonically increases throughout. The driving forces behind this mean-reversion
include, most directly, the recipients’ consumption of much of the transfer, as well as efforts by the
donors to replenish their wealth balances. The relatively slow transition (with a half life of around
five years) reflects households’ attempts to smooth consumption, thus keeping wealth dynamics
rather slow.
We now turn to the impact of the wealth redistribution program on macroeconomic aggregates.
Figure 3 shows that the effect of the transfer program on aggregate output, consumption, investment, and hours is bounded above by around 2 percent. Output falls, as noted above, but does
so over the entire transition by no more than one-quarter of 1 percent. In terms of dynamics,
we see that the initial decline in output is followed by a slow increase over time as the economy
returns to its pre-transfer steady-state equilibrium. If aggregate output does not change by much,
its composition changes much more noticeably, with a boom in consumption and a bust in investment. There is also a large drop in hours worked, but a much more muted reduction in effective
hours worked, i.e., the total amount worked weighted by individual labor productivity. This compositional change therefore generates an increase in aggregate labor productivity. As implied by
proposition 1, the small drop in effective hours worked explains the small drop in output and the
negative co-movement between consumption and investment. Remarkably, all aggregates have a
fairly long transition back to their steady states, with half-lives of approximately five years, like
24
Figure 2: Gini Coefficient
0
−0.5
−1
−1.5
−2
−2.5
0
5
10
15
20
25
t
Gini coefficient.
In order to understand the link between the aggregate results and the intuition developed
through analytics in Section 3, it is useful to observe the average sensitivity of agents’ behavior
within a given wealth category to changes in their wealth. We construct two related decompositions
in Tables 2 and 3. Each element in these two tables reports the contribution – via wealth effects
alone – of individuals in a given wealth (Table 2) or productivity (Table 3) category to the total
change
in a given
More precisely,i the elements of the first column of Table 2 are given by
hP
aggregate.
P
∂a00 (a,s)
− 1 x(a)Γ (a, s) da /A0 , with Ak denoting different wealth quantiles, and
s∈S
a∈Ak
∂a
P
s∈Sk
P
a∈A
∂a00 (a,s)
−1
∂a
x(a)Γ(a,s)da
the elements in the first column of Table 3 are given by
, where
A0
Sk are different productivity groups. Other columns in the two tables are defined similarly. This
decomposition is accurate when that wealth redistribution is small relative to individual wealth
holdings. Furthermore, it provides an accurate decomposition of total changes in the various
aggregates to the extent that changes in the policy function induced by general equilibrium effects
of prices are relatively small.
The decomposition by wealth is depicted in Table 2. Recall that each of these numbers give
the total change within a given group. We see immediately that, in response to the transfer, lowwealth households contribute negatively to the change in aggregate savings rate, whereas wealth-rich
households contribute positively. Low-wealth households achieve lower savings both by increasing
their consumption and by decreasing their labor supply. In particular, the consumption boom is
25
Figure 3: Aggregate Variables
1
Consumption
Hours
Effective Hours
Assets
Output
0.5
0
−0.5
−1
−1.5
−2
0
5
10
15
20
25
t
disproportionately driven by those in the first quintile, who by themselves generate a 1.40 percent
change in total consumption from the steady state. We also see that the lower-wealth households
reduce their hours while those with higher wealth increase effort slightly. The more than proportional reduction in hours by low-wealth households explains the substantial drop in hours worked.
However, once weighted by productivity, higher-wealth groups’ aggregate effort rises substantially
more, since they are more likely to be also more productive. The net result is that wealth-rich
households nearly offset the decline in effective hours of wealth-poor ones.9
The correlation between wealth and productivity becomes apparent in Table 3, which organizes households by their idiosyncratic state s ∈ {1, 2, .., 8}. Before proceeding, we note that our
parameterization, following Castaneda et al. (2003), reserves states s = {5, ..., 8} to capture the
presence of retirees, who are not endowed with labor time, and differ only in the probability distributions that govern their return or rebirth into working life. The table shows that more productive
9
In effect, in the benchmark case of Cobb-Douglas preferences, one would expect higher productivity households
to change their leisure by proportionately less as compared to consumption, since, given their higher wages, a smaller
change in hours worked delivers the same change in expenditures with leisure.
26
Table 2: Decomposition of Changes in Aggregates by Wealth Quantile
Wealth Quantiles
First
Second
Third
Fourth
Fifth
Quintile
Quintile
Quintile
Quintile
Quintile
90-95
95-99
99-100
Total
S1 − S0
C1 − C0
L1 − L0
N1 − N0
-0.262
-0.0824
-0.0541
-0.012
0.105
0.0206
0.0349
0.0406
-0.3055
1.4
0.2082
0.1506
0.0417
-0.3344
-0.0581
-0.0541
-0.1912
1.4661
-0.3108
-1.0116
-0.6418
-0.1134
0.1414
0.0388
0.067
8.32E-04
-1.9361
-0.1393
-0.452
-0.2887
-0.0683
0.7413
0.1548
0.2887
0.2334
-0.207
households are more likely to reduce their consumption and increase their hours worked by more
than less productive households increase their consumption and decrease their hours worked. This
is consistent with the notion that productive households are being taxed whereas less productive
households are receiving transfers. We see the sharp drop in hours overall, as already noted, but
also the concentration of that drop among the relatively unproductive (s = 1), explaining the increase in aggregate labor productivity. As for consumption, the bulk of the boom is concentrated
in groups s = {5, .., 8}, encompassing the retirees, with their contribution to consumption growth
equaling 1.24 percent, roughly 85 percent of the total increase. This occurs because retirees effectively discount the future more heavily than other agents – they face a positive probability of
being replaced by a descendant they care for with a discount rate β, and who will be better off
than them. Furthermore, since they do not supply labor, all their dissaving takes place through
increased consumption rather than through reduced labor supply. As a result, this group has relatively diminished intertemporal smoothing motives and a higher marginal propensity to consume
than other groups, all else equal.10
Table 4 compares the effects upon impact of wealth redistribution with and without nominal
rigidities. The first two lines compare the results in the baseline case with standard Cobb-Douglas
production function. The changes in consumption and output in both cases is virtually identical.
This reflects the fact that the interest rate and wages change very little in the case without nominal
rigidities. Hence, general equilibrium effects play a very small role. For the case in which interest
rate is sensitive to changes in savings, both models with and without nominal rigidities generate a
boom in consumption and output, although the boom in consumption is smaller than in the first
two rows. It is notable that in the presence of nominal rigidities output rises by only half as much
as it does in its absence. Thus, it is not the case that nominal rigidities necessarily amplify the
output boom induced by redistributive shocks.
The analytical results in Section 3 imply that the aggregate impact of the redistribution shock
10
Note that the overall change in consumption predicted by the decomposition is about twice as large as the one
implied by the model. This is in large part an artifact of the linearization and, specifically, because the marginal
propensity to consume of the retirees falls very rapidly as their wealth increases.
27
Table 3: Decomposition in Changes in Aggregates by Exogenous State
exogenous state (s)
S1 − S0
C1 − C0
L1 − L0
N1 − N0
1
2
3
4
5
6
7
8
Total
-0.1517
0.0015
0.0572
0.0272
-0.2212
-0.0181
0
0
-0.3055
0.2732
-0.0215
-0.1113
-0.0073
1.2477
0.1053
-0.0135
-0.0065
1.4661
-2.0471
0.0047
0.1057
4.97E-04
0
0
0
0
-1.9361
-0.9006
0.0065
0.455
0.2322
0
0
0
0
-0.207
Table 4: The Role of Nominal Rigidities
C1 − C0
N1 − N0
Y1 − Y0
Baseline
λ=1
λ = 0.5
0.68
0.69
-0.01
-0.01
-0.00
-0.00
Sensitive Interest Rates
λ=1
λ = 0.5
0.31
0.27
0.27
0.14
0.10
0.08
28
on output is a function of preferences, the tax system and the incentives for precautionary savings.
To demonstrate the extent to which the intuitions developed in the analytical section inform the
quantitative results, we now examine alternative specifications. Table 5 shows how aggregate
responses upon impact change if we alter the specification of the model. The first line of the
table restates the results described in this section. Rows 2 and 3 in Table 5 show how removing
the progressivity of the tax code and making preferences homothetic both lead to a progressively
larger drop in effective labor supply and output on impact. This is in line with the discussion in
Section 3.2.2 and more specifically in Proposition 5 and Lemma 1, regarding how, respectively, nonhomotheticity in preferences and a progressive tax-code lead wealthy households to choose to spend
proportionately more on leisure than on consumption. Once we make preferences homothetic and
taxes linear, the wealthy reduce their expenditure on leisure by less than in the baseline case, thus
also increasing their labor supply by less. Row 4 shows that increasing the sensitivity of interest
rates to savings (by introducing more concavity to capital in the production function) suppresses
the increase in consumption and leads to an output boom. This highlights the role of inter-temporal
choices in keeping aggregate labor supply from rising in the baseline model. With sensitive interest
rates, aggregate savings change by less in equilibrium, and intra-temporal choices dominate.
The last two lines of Table 5 examine whether some of the special assumptions made in Castaneda et al. (2003) to allow the model to match the extremely skewed wealth distribution could
be driving the results. Rows 4 and 5 present the results when the model is calibrated as in Floden
(2001) and Alonso-Ortiz and Rogerson (2010), respectively. In both these cases there is a clear
decline in hours and effective hours. The parametrization in Alonso–Ortiz and Rogerson (2009)
presumes indivisble labor. As highlighted by Proposition 6, the fact that output falls in that case
suggests that given the proposed redistributive policy, recipients are more likely to be close to the
margin between working and not working.
Table 5: Alternative Parameterizations
C1 − C0 L1 − L0 N1 − N0 Y1 − Y0
Baseline
Flat tax
Flat tax, homothetic
Sensitive Interest Rates
Floden (PE)
Alonso-Ortiz and Rogerson
6
0.69
0.74
0.74
0.31
0.44
0.31
-1.72
-2.04
-2.26
-1.18
-0.83
-6.49
-0.01
-0.08
-0.32
0.43
-0.34
-1.85
-0.01
-0.05
-0.2
0.27
-1.19
% of Households better off
75.16
75.57
77.11
69.93
68.46
Conclusion
The recent recession has brought attention to the possibility that wealth redistribution can stimulate
output. In this paper, we have taken a step, both analytically and quantitatively, in evaluating
the aggregate impact of short-term redistributive economic policy that transfers wealth from rich
29
to poor households. Our benchmark is a standard incomplete-markets model of consumption and
labor supply that incorporates nominal rigidities and, in its quantitative version, also accurately
captures the U.S. wealth distribution. We show that the conventional intuition with respect to the
stimulative effect of wealth redistribution indeed holds for the behavior of aggregate consumption.
However, we show that while redistributive policies can have a stimulative impact on consumption,
their effect on aggregate output depends, potentially quite importantly, on the nature of household
labor supply. In particular, we highlight the role of wealth effects on labor that, in our quantitative
model, are strong enough to overturn the output effects of the consumption boom altogether.
7
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8
Proofs of Propositions
Proofs of Propositions 1 through 3:
See text.
Proof of Proposition 4:
Let A− = {a|x (a) < 0}, A+ = {a|x (a) > 0}. Then
Z
Z
x (a) Γ (a) da =
a∈A−
x (a) Γ (a) da = M
a∈A+
static
(z(a,s),s,w0 )
(a,s) ∂ε(s)l
denote the marginal propensity
For notational simplicity, let m (a) ≡ ∂z0∂a
∂z
to work out of wealth.
Since x (a) is decreasing in a, it follows that if a ∈ A+ and a0 ∈ A− , then a < a0 . Moreover,
by assumption, |m (a)| is increasing in a. It follows from both of these observations that, for all s,
supa∈A+ |m (a)| ≤ inf a∈A− |m (a)|. Thus,
Z
x (a) |m (a)| Γ (a) da < M sup |m (a)| ≤
a∈A+
a∈A+
≤ M inf |m (a)|
a∈A−
Z
<
x (a) |m (a)| Γ (a) da .
a∈A−
32
Therefore
Z
Z
x (a) |m (a)| Γ (a) da < 0,
x (a) |m (a)| Γ (a) da +
a∈A−
a∈A+
and
Z
x (a) m (a) Γ (a) da > 0.
a∈A+
The proof for the converse case in which
ogous.
∂z0 (a,s) ∂ε(s)lstatic (z(a,s),s,w0 )
∂a
∂z
Proof of Proposition 5:
wt ε(s)(l̄−ltstatic (z,s,wt ))
Let µ (z, s, wt ) =
, so that ltstatic (z, s, wt ) = ¯l −
z
all t,
is decreasing in a is anal-
µ(z,s,wt )z
wt ε(s)
We have that, for
1
∂ε (s) l0static (z, s; w)
= − [µz (z0 (a, s) , s, w0 ) z0 (a, s) + µ (z0 (a, s) , s, w0 )] ,
∂a
wt
Thus,
in z if
∂ε(s)l0static (z,s;w)
∂a
increases with z if µz (z, s, wt ) z+µ (z, s, wt ) to increase with z. It is increasing
µzz (z, s, w0 ) z + 2µz (z, s, w0 ) > 0
0 )z
This will be true if µz (z, s, w0 ) > 0 (leisure is a luxury) and µµzzz (z,s,w
(z,s,w0 ) > −2. Conversely,
N1 − N0 < 0 if µz (z, s, wt ) z + µ (z, s, wt ) decreases with z. This will be the case if
µzz (z, s, w0 ) z + 2µz (z, s, w0 ) < 0
Which is the case if µz (z, s, w0 ) < 0 (leisure is a necessity) and
µzz (z,s,w0 )z
|µz (z,s,w0 )|
Proof of Corollary 1
In the case of separable utility, we have that
wε (s) c−σC = χ ¯l − l
−σL
The budget constraint is:
wε (s) ¯l − l + c = z
Bringing the two together defines µ (z, s, w) implicitely as
− σ1
µ (z, s, w) + χ
C
wε (s)
1−σL
σC
33
σL
σL
µ (z, s, w) σC z σC
−1
=1
<2
From the implicit function theorem, we have that
− σ1
σL
µz (z, s, w) = 1 −
σC
χ
C
wε (s)
1−σL
σC
1
1+
σ L − σC
σC χ
wε (s)
σL
σL
µ (z, s, w) σC z σC
1−σL
σC
−2
σL
(µ (z, s, w) z) σC
−1
Thus, µz (z, s, w) > 0 if σL < σC and µz (z, s, w) < 0 otherwise. Also, taking natural logarithms
on both sides and differentiating with respect to ln z yields
µzz (z, s, w) z
µz (z, s, w)
σL µz (z, s, w) z
σL
−2
+
σC µ (z, s, w)
σC
=
1
σL − σ C
χ
σC
−
1
σL − σC
σC χ
1+
Note that
σL
σC
χ
σ
1+ σ L
C
− σ1
C
wε(s)
− 1
χ σC
wε (s)
1−σL
σC
wε (s)
σL
µzz (z,s,w)z
µz (z,s,w)
µzz (z, s, w) z
σL
=
|µz (z, s, w)|
σC
µzz (z,s,w)z
|µz (z,s,w)|
−1
σL
(µ (z, s, w) z) σC
−1
σL
µz (z, s, w) z
−1
+1
σC
µ (z, s, w)
−1
σL
−1
(µ(z,s,w)z) σC
µzz (z, s, w) z
σL
=
µz (z, s, w)
σC
So that
σL
(µ (z, s, w) z) σC
1−σL
σC
(µ(z,s,w)z) σC
1−σL
wε(s) σC
So that if µz (z, s, w) > 0,
1−σL
σC
=
σL µz (z,s,w)z
1
,
σ
1− σ L σC µ(z,s,w)
so that
C
µz (z, s, w) z
+2
µ (z, s, w)
µz (z, s, w) z
σL
+
−2
µ (z, s, w)
σC
> −2. If µz (z, s, w) < 0, we have that
|µz (z, s, w)| z
2−
µ (z, s, w)
|µz (z, s, w)| z
σL
−
+2
µ (z, s, w)
σC
< 2 if
σL
σC
|µz (z, s, w)| z |µz (z, s, w)| z
σL
2−
<
µ (z, s, w)
µ (z, s, w)
σC
Simplifying and rearranging,
|µz (z, s, w)| z
µ (z, s, w)
Note that the LHS is equal to zero if
2
−2
|µz (z, s, w)| z
+1>0
µ (z, s, w)
|µz (z,s,w)|z
µ(z,s,w)
= 1. Also, if we take the first derivative of the
|µz (z,s,w)|z
µ(z,s,w)
= 1, we see that this is a local minimum. Thus, unless
LHS and set
condition is satisfied. This would require
σC
1−
σL
1
σL − σ C
σC χ
1+
wε (s)
1
σL − σC
σC χ
1−σL
σC
wε (s)
σL
(µ (z, s, w) z) σC
1−σL
σC
|µz (z,s,w)|z
µ(z,s,w)
−1
σL
(µ (z, s, w) z) σC
−1
=1
Under the assumption that σL > σC (so that µz (z, s, w) < 0), we have that 0 <
34
= 1, the
σC
σL
< 1, so that
1−
σC
σL
< 1. Also,
σL
σC
χ
− σ1
C
σ
1+ σ L χ
wε(s)
− σ1
C
C
µzz (z,s,w)z
|µz (z,s,w)|
1−σL
σC
wε(s)
σL
(µ(z,s,w)z) σC
1−σL
σC
−1
σL
(µ(z,s,w)z) σC
−1
< 1, so that the equality cannot hold. Thus,
< 2.
Proof of Lemma 1
The intra-temporal optimality condition is
c=
κ
wε (s) 1 − τ 0 (ra + wε (s) l + ω (s)) ¯l − l
1−κ
Given the definition
wε (s) ¯l − l0 (a, s)
µ0 (a, s) =
c0 (a, s) + wε (s) ¯l − l0 (a, s)
we have that
µ0 (a, s) =
κ
1−κ
(1 −
τ 0 (ra
1
+ wε (s) l (a, s) + ω (s))) + 1
Thus,
κ
∂µ0 (a, s)
=
∂a
1−κ
τ 00 (ra + wε (s) l + ω (s))
κ
1−κ
(1 − τ 0 (ra + wε (s) l (a, s) + ω (s))) + 1
If taxes are progressive, so that τ 00 (ra + wε (s) l + ω (s)), then
2
∂ (ra + wε (s) l (a, s))
∂a
∂µ0 (a,s)
∂a
> 0.
Proof of Proposition 6
We want to consider the impact of an infinitesimally small redistribution program. We consider
a sequence of vanishingly small programs with transfers to hosueholds with wealth level a given
by υx1 (a), where υ is a perturbation parameter. Under the indivisible labor case, effective labor
supply at t = 0 and t = 1 is, in partial equilibrium, given by
Z
X
N0 = ¯l
ε (s)
1 (a ≤ ā (s)) Γ0 (a, s) da
s∈S
a∈A
υx1 (a)
1 a+
≤ ā (s) Γ0 (a, s) da
1+r
a∈A
Z
X
¯
N1 = l
ε (s)
s∈S
35
To characterize the change in effective labor supply given the program, we take the limit
Z
X
N1 − N0
1
(a
+
υx
(a)
≤
ā
(s))
−
1
(a
≤
ā
(s))
1
Γ0 (a, s) da
lim
= lim ¯l
ε (s)
υ→0
υ→0
υ
υ
a∈A
s∈S
Z
X
1 (a + υx1 (a) ≤ ā (s)) − 1 (a ≤ ā (s))
¯
= lim l
x1 (a) Γ0 (a, s) da
ε (s)
υ→0
x1 (a) υ
a∈A
s∈S
R ā(s)
X
ā(s)−u x1 (a) Γ0 (a, s) da
= ¯l
ε (s) lim
u→0
u
s∈S
where in the last line we substitute x1 (a) υ ≡ u. Using L’Hospital’s rule and Leibniz rule,
R ā(s)
∂
N1 − N0 ¯X
ε (s) lim
=l
lim
u→0
υ→0
υ
s∈S
ā(s)−u
x1 (a)Γ0 (a,s)da
∂u
∂u
∂u
X
x1 (ā (s) − u) Γ0 (a, s) da
= ¯l
ε (s) lim
u→0
1
s∈S
X
= ¯l
ε (s) x1 (ā (s)) Γ0 (a, s) da
s∈S
36
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