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The effect of anticipated tax changes on intertemporal labor supply and the realization of taxable income

W. Looney and Monica Singhal ()

No 2005-44, Finance and Economics Discussion Series from Board of Governors of the Federal Reserve System (U.S.)

Abstract: We use anticipated changes in tax rates associated with changes in family composition to estimate intertemporal labor supply elasticities and elasticities of taxable income with respect to the net-of-tax wage rate. A number of provisions of the tax code are tied explicitly to child age and dependent status. Changes in the ages of children can thus affect marginal tax rates through phase-in or phase-out provisions of tax credits or by shifting individuals across tax brackets. We identify the response of labor and income to these tax changes by comparing families who experienced a tax rate change to families who had a similar change in dependents but no resulting tax rate change. A primary advantage of our approach is that the changes are anticipated and therefore should not cause re-evaluations of lifetime income. The estimates of substitution effects should consequently not be confounded by life-cycle income effects. The empirical design also allows us to compare similar families and can be used to estimate elasticities across the income distribution. In particular, we provide estimates for low and middle income families. Using data from the Survey of Income and Program Participation (SIPP), we estimate an intertemporal elasticity of family labor earnings close to one for families earning between $30,000 and $75,000. Our estimates for families in the EITC phase-out range are lower but still substantial. Estimates from the IRS-NBER individual tax panel are consistent with the SIPP estimates. Tests using alternate control groups and simulated "placebo" tax schedules support our identifying assumptions. The high-end estimates suggest substantial efficiency costs of taxation.

Date: 2005
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Related works:
Working Paper: The Effect of Anticipated Tax Changes on Intertemporal Labor Supply and the Realization of Taxable Income (2006) Downloads
Working Paper: The Effect of Anticipated Tax Changes on Intertemporal Labor Supply and the Realization of Taxable Income (2006) Downloads
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