Micro and macro elasticities in a life cycle model with taxes

We build a life cycle model of labor supply that incorporates changes along both the intensive and extensive margin and use it to assess the consequences of changes in tax and transfer policies on equilibrium hours of work. We find that changes in taxes have large aggregate effects on hours of work. Moreover, we find that there is no inconsistency between this result and the empirical finding of small labor elasticities for prime age workers. In our model, micro and macro elasticities are effectively unrelated. Our model is also consistent with other cross-country patterns. ∗We thank Ed Prescott, Martin Evans, Nobu Kiyotaki, Robert Hall, Fernando Alvarez and seminar participants at the University of Pennsylvania, University of Maryland, Georgetown University, ASU, Kansas City Fed, Philadelphia Fed and Atlanta Fed for useful comments. An earlier version of this paper was presented at the conference in honor of Robert Lucas held in Chicago, April 2007. Rogerson thanks the NSF for financial support, and Wallenius thanks the Yrjo Jahnsson Foundation for financial support.