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IZA Labor Supply Workshop, Dublin 18-19 May 2012 Thor Olav Thoresen, Statistic Norway

Income Responses to Tax Changes. Reconciling Results of Quasi-Experimental Evaluation and Structural Labor Supply Model Simulations. IZA Labor Supply Workshop, Dublin 18-19 May 2012 Thor Olav Thoresen, Statistic Norway Trine Engh Vatt ø, Statistic Norway. Idea.

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IZA Labor Supply Workshop, Dublin 18-19 May 2012 Thor Olav Thoresen, Statistic Norway

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  1. Income Responses to Tax Changes. Reconciling Results of Quasi-Experimental Evaluation and Structural Labor Supply Model Simulations IZA Labor Supply Workshop, Dublin 18-19 May 2012 Thor Olav Thoresen, Statistic Norway Trine Engh Vattø, Statistic Norway

  2. Idea • Estimate the labor income responses to a Norwegian tax reform in 2006 -> Directly compare a structural and experimental approach • Focus on prime age wage earners

  3. Outline • Introduction • Institutional Background • (A) Structural Approach • (B) Experimental Approach • Comparison • Summary and Conclusion

  4. Introduction: Two conventional approaches • Structural Discrete Choice Approach • Estimate parameters of utility function using cross sectional data • Report gross wage elasticities • Experimental Approach • Use actual taxable income data pre- and post-reform • Report elasticity of taxable income wrt (1-marginal tax)

  5. Institutional background: The Norwegian Tax Reform 2006 • Wage Earners: • - General tax rate (35.8 %) • - Surtax rates (13.5 % & 19.5 % -> 9 % & 12 %)

  6. (A) Structural Approach • Discrete job choice framework (Dagsvik and Strøm, 2006 and Dagsvik and Jia, 2012) • Estimate Box-Cox utility function by multinomial logit (11 discrete hour-choices) with random wage rate component -> Maximum simulated likelihood • Data source: Labor Force Survey, 2004 • Post estimation: • Wage elasticities • Predicted hours of work pre and post reform

  7. Structural Model of Labor Supply • Model is separately estimated for men in couple, women in couple, single men and single women.

  8. Simulation Results Hours Predicted hours per week pre- and post-reform 8

  9. (B) Experimental Approach • Framework see e.g. Gruber, Saez (2002) • Evaluate pairs of 3-year panels on (taxable) labor income year 2000-2008 -> “Income statistics for persons and families” • Measure the elasticity of earnings w.r.t. net of tax rate (capture responses in hours worked and wages)

  10. Empirical Specification = Elasticity of earnings with respect to net-of-tax 10

  11. Empirical Specification = Elasticity of earnings with respect to net-of-tax Instrument (standard in ETI-literature) Mean Reversion/Income distribution trends ->Third degree polynomial of -> Exclude individuals with income below percentile 33 11

  12. Results Experimental Approach: Elasticity of Taxable Earnings Note: All regressions include control variables for gender, wealth, age, age squared, married, number of children under and above 6, newborn, residence in Oslo/ dense populated area, non-west origin, years of education, dummies for education area, income shifting control and year dummies. 12

  13. Results Experimental Approach: Elasticity of Taxable Earnings

  14. Comparing Models: Wage elasticities versus elasticity of taxable earnings • Wage elasticities -> % change in predicted hours as gross wage increase by 1 % • Elasticity of taxable earnings -> % change in labor income as (1-marginal tax rate) increase by 1 % • Comparable? • Only if • Wage elasticities-> % increase net wage given tax rate • Elasticity of taxable earnings-> constant over income distribution If not: Measured elasticity of taxable earnings-> Reform-dependent

  15. How to compare results from structural and experimental approach? • Structural model • Simulate hours worked -> predict labor income • Instrument net-of-tax based on pre reform simulated income • Regress growth simulated income on net of tax instrument - Compare results with experimental net of tax elasticities approach

  16. Summary Results • Predictions with ETE=0.05 • Tax reform: Top tax decreased from 55.3% to 47.8% • About 15 percent increase in net of tax -> 0.75 percent increase in labor income

  17. Framework differences • Discrete/Continuous choice • Structural model: Discrete choice -> probability distribution – all “treated” • Experimental model: “Treatment and control group” • Responses through • Structural model: Actual working hours • Experimental model: Labor Income (working hours x wage) • Time Frame • Structural model: Static, long run(?) • Experimental model: “static” 3 year panels • Still, results seem reasonable similar -> both measure low responses

  18. Summary and Conclusion • Gross wage elasticities from discrete choice models should not be directly compared to reform-dependent net-of tax elasticities • Comparing a structural and experimental approach to a Norwegian tax reform 2006 (where surtax rates were decreased) • Both point to elasticities of taxable earnings of about 0.05

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