7 - Labour supply and taxes Flashcards
why are labour supply responses important to consider when choosing tax rates
- if people arent very responsive then we can carry out a lot of redistribution without efficiency loss
the more elastic tax payers are..
the lower the optimal tax rate
- efficiency loss
what are the 2 dimensions of labour supply responses
- intensive = hours of work
- extensive = whether to work or not
what happens to reported earnings at the top of the income distribution
- tax avoidance = legal
- tax evasion = illegal
income effect
the pound increase in earnings if person receives £1 extra in non-labour income
- IE = wdl/dR
what is the Slutsky equation
eu = ec + IE
what does uncompensated elasticity of labour supply
the % change in hours when net wage w increases by 1%
what is compensated elasticity
choice between consumption and leisure conditional on being on the same indifference curve
what is the basic OLS equation to estimate uncompensated elasticity of labour supply
dv = hours worked
ev = wage rate, non labour income, age demographic controls
coefficient B = uncompensated wage effects and Y measures income effects
what are the findings for OLS regression to find eu
- small elasticities for men
- large elasticity for women - because secondary earner = but reduces the more women work
what are the issues with OLS regression
assumption that wi is uncorrelated with ei error term inorder for B to be unbiased
- Omitted variable bias = highly skilled individuals compared to low have a higher taste for work - so earn more have higher w
- so will B will overestimate w
why is looking at tax changes better than OLS regression
- OLS = OVB - biased estimates
what is a good method used by literature to estimate elasticities
look at variation in taxes and transfers
- random experiment = not feasible
- natural experiments
Ashenfelter 1990
what do they test and do
- randomised experiment
- exogenously changes taxes and transfers
- what is the effect of increasing tax rate/ increasing G –> on labour supply - how does it effect hours worked
- several random groups with 75 hhs in each group
what is the graphical response from going from control group of no tax and grant –> to G and tax rate
- negative income and substitution effect
- ambiguous effect on C
what were the findings from negative income tax experiments
Ashenfelter 1990
- statically significant labour supply response but small
- earnings elasticity 0.1 for men = 1% increase in net of tax rate = increases hours worked by 0.1 hours
- earnings elasticity 0.5 for women - concentrated at extensive margin
why are randomised experiments rare
what to use instead
- costly to implement
natural experiments = natural variation that can be exploited
Imbens 2001
what did they do and what were they testing
do people change their hours of work after they win the lottery (pure income effect)
- survey of lottery winners and nonwinners - did they change hours worked
- lottery = random assingment
- non winners = control
- winners
- diff in diff
Imbens 2001
what did they find
whats a problem with this
- small income effects between -0.05 and -0.1
- survey has problem of attrition = lazy people more likely to drop = same people likely to stop working
- so the results could be underestimation
Cesarini 2017
what did they do and what were they testing
- swedish bank detail
- look at effects of wealth on individuals income earnings
- no attrition
- extensive and intensive labour supply
- small significant income effect
- effects the spouse but not as much as the winner
Tazhitdinova (2022)
what did they do and what were they testing
testing for labour supply substitution effects
- uses 2003 German reform that made secondary jobs (paying less than 400 a month) tax free –> changed the tax rate
- what is the effect on percentage of people holding secondary jobs over time
- diff in diff
what is the key assumption for diff in diff
parallel trend assumption
- T and C has to be parallel before
- assume T would be where C is without the reform
Tazhitdinova (2022)
what did they find
- more people took secondary jobs
- <400 = 7% from 2.5%
- 400<1000 - drop in jobs because of notch
- > 1000 = no effect
- people didnt reduce primary jobs
what was the US welfare to workfare reform
1996
- provides more incentives to work
- require them to get job training
- limiting the duration of benefits
- reducing phase out rates
Card (2022)
what did they do and what were they testing
- what is the employment effect after earnings subsidy given to treatment group for 36 months in 1990s
- significant tax cut = incentivise people to work
- control dont get the subsidy
Card (2022)
what did they find
- subsidy increases employment during the experiment relative to control
- effect vanishes when the subsidy stops - by month 52 employment is same level as control
- no LR effects in employment from subsidy
what is the EITC
- largest means tested cash transfer for US
- eligible = low earning families with kids
- refundable tax credit
- pyramid shape - phase in, plateau, phase out
- should encourage people to work - extensive labour supply margin
what is the intensive labour supply response for EITc
phase in = ambiguous
plateau = reduce work
phase out = reduce work
kleven 2019
did EITC increase LFP for single women with kids
- treatment = with kids
- control = without kids
- yes singificant increase in LFP for single women with kids following 1990 expansion of EITC
- unlikely that EITC explains all - changing social norms, economic boom, welfare reform
- means that EITC didnt have such a big effect as initially thought
what is the difference between kinks and notches
kinks = continuous tax function
- only taxed on that area
notch = discontinuous tax function
- taxed on all income
what is a benefit of looking at notches
can learn what fraction of population is truly unresponsive - because no rational person would choose to be in area after notch = dominated area
- kink = cant distinguish what is due to frictions/unresponsiveness
why is there a decrease in density after the kink
- people in area right after the kink move to bunch at B
- still people in the space right next to the kink because people move down still
- is not a dominated area
Saez 2010
what do they do
- uses individual tax return data from 1960-2004
- observes if there is bunching at EITC kinks
Saez 2010
what do they find
- finds bunching at first kink of EITC mainly for self employed
- lower mass to the right of the kink for self employed
- finds bunching at first tax bracket where liability starts
- no bunching at other kinks
why is there a bigger response for self employed than wage earners
- wage earners = not flexible - cant change hours worked
- self employed - want to maximise tax refund - cheating
why is there not more bunching at kinks
- true intensive elasticity of response maybe small - people arent responsive to the tax changes
- frictions = adjustment costs stop from bunching
- information and salience
how do adjustment costs prevent bunching
what are examples of the costs
- if costs are too high then people wont respond to small tax changes
- getting info about taxes
- institutional constraints about hours worked - contracts
why do self employed and secondary workers react more to tax changes
- they are more flexible
- dont have institutional constraints
- can easily adjust there hours to reoptimise
Chetty 2011
what do they do
- how are elasticities effected by frictions
- use panel data with admin tax records for Denmark population
- uses administrative data
- highest change in tax rate for Denmark at highest kink = -29%
- so would expect to see most bunching at the highest kink
Chetty 2011
what do they find in terms of kinks
- top kink = extra mass of distribution at top kink
- no bunching for single men
- bunching at top kink for married women (secondary earners)
bunching at top kink and middle for self employed
- the larger the tax change = the higher the elasticity
Chetty 2011
what do they find
main takeaways
- larger elasticities around larger kinks
- groups with more flexibility - respond more (more bunching for self employed and married women)
- elasticities are small (frictions)
- if adjustment cost is higher than benefit of labour supply change = no bunching
why is evidence of response along extensive margin but little along intensive margin a good thing
- EITC induces people to work along extensive margin
- without discouraging work along intensive margin
Chetty 2013
what do they do
what are they testing that is different
- use US population tax return data from 1996
- compare income distribution for wage earners in areas of high bunching (are aware of EITC) and low bunching areas (not aware)
- look at what happens to wage earning distribution after the first birth of child - compare for low bunching/middle/high bunching deciles
Chetty 2013
what do they find
tells us how much of bunching is due to labour supply responses and what is due to frictions (they dont know)
splitting wage distribution into high bunching areas and low bunching
- the difference between the 2 can be explained by the fact that they are unaware of the program = lack info
- first child = before the first child - no difference, after first child - no change in distribution for lowest bunching decile, but bunching at kinks for highest decile
what are the frictions on wage earners that prevent them from optimising their labour choices
- adjustment costs (fixed pay structures)
- cant change hours - not flexible
- inattention
- lack of info - not salient
what is the difference in bunching graphs of kinks and notches
kink
- see bunching to the left
- slight decrease on the right (but not that much)
- not dominated - can enjoy higher income and higher consumption
notch
- bunching to the left
- bigger dip to the right = dominated area
- if still mass on the right = inattentive people
which kinds of people are most driving bunching at UK kinks
- self employed
- big bunching in company owners - easier for them to tax avoid (shift income)
evidence of bunching at the minimum weekly hours of work requirment
16+ hours
- bunching at 16 hours for single women with kids
- no bunching for single women without kids = not eligible for WTC
how did social norms play a role in female labour supply
- after the war = big increase in labour supply - an increase not due to increase in w or R
what is the child penalty
the decrease in relative earnings between men and women after women gives birth
- 2 years after birth = 60% drop in earnings that doesnt catch back up
