Taxes, Wages and Working Hours

Taxes, Wages and Working Hours This paper presents estimates of individuals’ responses in hourly wages to changes in marginal tax rates. Estimates based on register panel data of Swedish households covering the period 1992 to 2007 produce significant but relatively small net-of-tax rate elasticities. The results vary with family type, with the largest elasticities obtained for single males and the smallest for married/cohabitant females. Despite these seemingly small elasticities, evaluation of the effects of a reduced state tax using a microsimulation model shows that the effort effect matters. The largest effect is due to changes in number of working hours yet including the effort effect results in an almost self-financed reform. As a reference to the earlier literature we also estimate taxable income elasticities. As expected, these are larger than for the hourly wage rates. However, both specifications produce significantly and positive income effects. NON-TECHNICAL SUMMARY Many studies of the behavioral effects of taxes assume that individuals only response is in working hours. This paper extends the behavioral effects to also include change in hourly wage rates. A decrease in tax rates may also affect the willingness to accept a management position, working inconvenient hours, moving to a higher paid job or investing in human capital. An evaluation of a decreased state tax in Sweden shows that both the labor supply and hourly wage effects are important. Including both effects indicate that the dynamic effects are so large that the reform is financed up to almost 80 percent. JEL Classification: C8, D31, H24, J22, J31