Substitution and Income Effects of Labor Income Taxation

Michael Graber, Morten Håvarstein, Magne Mogstad, Ola L. Vestad and Ola L. Vestad
Authors registered in the RePEc Author Service: Gaute Torsvik and Ola Lotherington Vestad

No 34987, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: The elasticity of taxable income (ETI) parameter is a key quantity in empirical analysis of tax policy and labor supply. We examine when a commonly applied class of ETI estimands can be used to learn about individuals’ ETI parameters and their (un)compensated elasticities of labor supply. We begin by providing necessary and sufficient conditions for these estimands to be given a causal interpretation as a positively weighted average of heterogeneous ETI parameters. We then apply these results to empirically analyze a reform of the Norwegian tax system that reduced the marginal tax rates on middle and high incomes. The estimated ETI parameters increase steadily with income, meaning high-income individuals are more responsive to tax changes than middle-income individuals. Next, we show how (un)compensated elasticities of labor supply can be bounded directly from the ETI estimands, or point identified by combining these estimands with estimates of earnings responses to lottery winnings. The results suggest an (un)compensated elasticity of 0.1 (0.0) for middle-income individuals. The (un)compensated elasticity estimates increase steadily with income to around 0.45 (0.3) for high-income individuals. These findings imply a substantial excess burden of taxation, and that reducing top-income tax rates would increase tax revenue. Our findings are also informative about how the intertemporal elasticity of substitution and the Frisch elasticity vary across the income distribution.

JEL-codes: C26 C36 H20 J22 (search for similar items in EconPapers)
Date: 2026-03
New Economics Papers: this item is included in nep-lab, nep-lma, nep-pbe and nep-pub
Note: LS PE
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