Standard Deviation Abstract

Standard Deviation Abstract

The purpose of this study is to show how taxes affect hours worked in a model where hours and wages are jointly determined. Standard labor supply elasticities measure the relationship between labor supply and the wage. Tax analysts use these estimated labor supply elasticities

to predict the labor supply response to a tax change. However,

tax analysts usually fail to account for the effect of hours worked on the

wage. This failure creates a problem because a tax increase not only lowers

the after-tax wage because of a change in the marginal tax rate but also

indirectly lowers the pre-tax wage through the tax change’s effect on hours

worked. Therefore, failure to account for this latter effect leads to an

underestimate of the effect of tax changes on the post-tax wage and consequently

to an underestimate of the effect of tax changes on labor supply.

hours worked in a model where hours and wages are jointly determined.

Standard labor supply elasticities measure the relationship between labor

supply and the wage. Tax analysts use these estimated labor supply elasticities

to predict the labor supply response to a tax change. However,

tax analysts usually fail to account for the effect of hours worked on the

wage. This failure creates a problem because a tax increase not only lowers

the after-tax wage because of a change in the marginal tax rate but also

indirectly lowers the pre-tax wage through the tax change’s effect on hours

worked. Therefore, failure to account for this latter effect leads to an

underestimate of the effect of tax changes on the post-tax wage and consequently

to an underestimate of the effect of tax changes on labor supply.

The second purpose of this article is to provide new estimates of the

effect of work hours on the wage. In order to estimate the effect of hours

worked on the wage, we must overcome an important identification problem.

It is not clear whether changes in hours affect wages or...