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  • ESSAYS IN OPTIMAL

    GOVERNMENT POLICY

  • c© Aart Gerritsen, 2014

    ISBN: 978 90 361 0381 7

    Cover design: Crasborn Graphic Designers bno, Valkenburg a.d. Geul

    This book is no. 577 of the Tinbergen Institute Research Series, established through cooperation between Thela Thesis and the Tinbergen Institute. A list of books which already appeared in the series can be found in the back.

  • ESSAYS IN OPTIMAL GOVERNMENT POLICY

    Essays over optimaal overheidsbeleid

    PROEFSCHRIFT

    ter verkrijging van de graad van doctor aan de Erasmus Universiteit Rotterdam

    op gezag van de rector magnificus

    Prof.dr. H.A.P. Pols

    en volgens besluit van het College voor Promoties.

    De openbare verdediging zal plaatsvinden op

    vrijdag 21 februari 2014 om 9:30 uur

    door

    Adrianus Anthonius Franciscus Gerritsen geboren te Utrecht

  • Promotiecommissie

    Promotor: Prof.dr. B. Jacobs

    Overige leden: Prof.dr. A.J. Dur

    Prof.dr. R.W. Boadway

    Prof.dr. F. van der Ploeg

  • Aan mijn ouders

    Adrianus (Adrie) Wilhelmus Gerritsen

    Elisabeth (Bets) Francisca Gerritsen-Van Amerongen

  • Preface

    Being a Ph.D. student has had a profound impact on my life, an impact that

    can hardly be overstated. It allowed me to learn more about economics, public

    finance, policy making, and political philosophy than I did in the preceding twenty

    three years combined. It provided me with a framework to analyze issues of an

    economic or moral nature, enabling me to think and form judgments critically and

    independently. In short, it allowed me to grow up intellectually. I am fully aware

    of how privileged I am for having been granted such opportunity, and am grateful

    beyond words to those who enabled it.

    First and foremost, I owe a large debt of gratitude to Bas Jacobs, my supervisor.

    The way in which he welcomed me as part of his intellectual family has truly been

    heartwarming. Indeed, the term ‘family’ is hardly an exaggeration. His devotion

    to my academic development has been of an intensity and a selflessness commonly

    only observed among families. He invested his time and effort not just in improving

    my thesis, but in fostering a personal relationship that made collaboration with

    him a real pleasure. He had faith in me during times in which I had very little left

    of it myself, and whenever I was convinced a ceiling had been reached, he always

    managed to stimulate me to carry my work to a higher level. I could not have

    wished for a better or more involved supervisor.

    I am happy to have had Ruud de Mooij as a second supervisor during the first

    year of my Ph.D., before he left for the IMF. I look back with fond memories to

    many coffees, lunches, and dinners I shared with him and Bas, and it is always a

    great pleasure to see Ruud at any of the international conferences or in Washington,

    D.C.

    Ever since my first international conference, the 2010 meeting of the Canadian

    Public Economics Group in Quebec City, Robin Boadway has been, for me, the

    personification of the international community of public economists that greatly

    enhanced my experience as a Ph.D. student. I am therefore very excited and

    thankful that he agreed to be a member of my doctoral committee. I also very

  • much appreciate the fact that Robert Dur, Rick van der Ploeg, Otto Swank, and

    Coen Teulings are willing to invest their scarce time in reading my dissertation

    and being members of my committee.

    Four years would have been a long time to survive without income. I therefore

    thank The Netherlands Organization for Scientific Research, which provided the

    financial support for my Ph.D. project under NWO Vidi Grant 452-07-013. I’m

    grateful to the support staffs of the Tinbergen Institute and the Economics depart-

    ment at the Erasmus University Rotterdam, that made sure my Ph.D. project ran

    smoothly despite my own disorganized mind. Without diminishing the gratitude I

    owe to the rest, I especially want to mention Carolien Stolting (TI) and Milky Vi-

    ola Gonzalez (EUR) for their help with getting my thesis published and defended,

    and Judith van Kronenberg (TI), whose unfailing cheerfulness is instrumental in

    making the Tinbergen Institute such a great place to work.

    I consider myself extremely lucky for having had Floris Zoutman and Hendrik

    Vrijburg around me at the Erasmus University. While I knew Floris from my

    time as a Master student in Groningen, we had not been in touch for a year until

    happy coincidence brought us back together as office mates. It was thrilling to

    see how little effect time had had on the fervor, the excitement, the depth of our

    discussions. Floris is also the direct cause of my biggest disappointment during my

    period as a Ph.D. student: I vowed to use our four years as office mates to teach

    him an appreciation of Bob Dylan, at which I miserably failed. Neither did we

    succeed in building that fort of empty coffee boxes, despite a no less than heroic

    attempt. On the upside, together we did manage to solve any problem we set our

    mind to, as long as there was a white board around.

    Being two years ahead, Hendrik has always been an important example to me. I

    greatly admire how he manages to soberly maintain his extraordinary involvement

    in everything he does, whether it concerns his research or teaching, his family

    including two young sons, or our common quest of discovering the most shady bar

    around any of the conference venues we visit. I have grown especially attached

    to our many coffees and lunches together, which never fail to provide either new

    insights or higher-order confusion regarding whatever topic that happens to be

    on the table. If the position of benevolent dictator ever becomes vacant, I would

    happily recommend both Floris and Hendrik.

    During the final months of my Ph.D., Uwe Thuemmel and Alexandra Rusu

    joined the Erasmus University as the latest scions of tree Jacobs. I would like to

    wish them both all the best in their academic career. I am looking forward to

  • seeing them more often in the years to come.

    I am grateful to Jacques Siegers, of whom I was a research assistant during my

    time as a Bachelor student in Utrecht. I still fret at the idea of what I would have

    done without his encouragement when I faced a temporary spell of severe disil-

    lusionment with economics. Jacques frequently mentioned that the chief purpose

    of granting me a research assistantship was to stimulate my interest in economics

    and academic scholarship. I hope he agrees that this purpose has been served well.

    My dissertation is dedicated to my parents who, from my earliest memories on,

    have stimulated my pursuit of knowledge. It was they, who taught me to read and

    write long before school would. It was they, who tirelessly tutored me whenever I

    had difficulties with a subject at school. It was they, who stimulated me to read,

    and read, and read. And, most importantly, it was they, who instilled in me an

    appreciation and respect for knowledge, the good, and the beautiful. I am also

    thankful to my brothers, Willem, Dirk and Tom, who helped me drown any of the

    superfluous brain cells that my parents provided me with.

    My dear Bahar. More than anyone else, you know the highs and the lows I

    experienced for my Ph.D. What is more, you were always there to sit them through

    with me. When things went well, you shared in my excitement. When I felt dis-

    couraged, you would lift my spirits. I hope you know how grateful I am for your

    support – it is essential to everything I do.

    Aart Gerritsen

    München, Winter 2013/2014

  • ‘It came into him life; it went out from him truth. It came to him short-lived actions; it went out from him immortal thoughts. It came to him business; it went from him poetry. It was dead fact; now, it is quick thought. It can stand, and it can go. It now endures, it now flies, it now inspires. Precisely in proportion to the depth of mind from which it issued, so high does it soar, so long does it sing.’

    Ralph Waldo Emerson

  • Contents

    Preface vii

    1 Introduction and summary 1

    2 Optimal taxation when people do not maximize well-being 15

    2.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15

    2.2 Optimal linear income taxation . . . . . . . . . . . . . . . . . . . . 20

    2.3 Optimal non-linear taxation . . . . . . . . . . . . . . . . . . . . . . 26

    2.4 The tax treatment of discrete decisions . . . . . . . . . . . . . . . . 31

    2.5 How far away from their bliss point are people? . . . . . . . . . . . 35

    2.6 Robustness . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45

    2.7 Concluding remarks . . . . . . . . . . . . . . . . . . . . . . . . . . . 49

    3 Minimum wages and taxation in competitive labor markets with

    endogenous skill formation 51

    3.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 51

    3.2 Related literature . . . . . . . . . . . . . . . . . . . . . . . . . . . . 55

    3.3 Model . . . . .