Taxation and Market Work: Is Scandinavia an Outlier?

This paper argues that in assessing the effects of tax rates on aggregate hours of market work, it is essential to explicitly consider how the government spends tax revenues. Different choices regarding government spending lead to different elasticities of hours of work with regard to tax rates. I illustrate the empirical importance of this point by addressing the issue of hours worked and tax rates in three sets of economies: the US, Continental Europe and Scandinavia. While tax rates are highest in Scandinavia, hours worked in Scandinavia are significantly higher than they are in Continental Europe. I argue that key differences in government spending can potentially account for this pattern. ∗An earlier version of the paper was presented at the 2002 conference in honor of Prescott being award the Nemmers Prize in Economics. I have benefitted from the comments of numerous seminar participants, but would like to particularly thank Robert Lucas, Ed Prescott, and Nancy Stokey. I thank the NSF for financial support.