Abstract
This applied theoretical paper finds that in-work benefits recipients tend to increase labor income, regardless of the benefits’ structure. A theory, the fixed cost of living, is used to explain this finding. Several applications of this theory are given. First, a critical review shows why the empirical papers are inconsistent. Second, using wage income elasticity to calculate optimal marginal tax rate is misleading for low income earners. Finally, in-work benefits should be part of the optimal labor income taxation.
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