The Speed of Earnings Responses to Taxation and the Role of Firm Labor Demand

Matthew Gudgeon and Simon Trenkle ()
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Simon Trenkle: IZA and IAB

No 13931, IZA Discussion Papers from Institute of Labor Economics (IZA)

Abstract: This paper studies the speed at which workers' pre-tax earnings respond to tax changes along the intensive margin. We do so in the context of Germany, where a large discontinuity - or notch - in the tax schedule induces sharp bunching in the earnings distribution. We analyze earnings responses to two policy reforms that shift this notch outward. In a frictionless world, the workers that made up the excess mass at the old notch should all increase their earnings. While some of these workers indeed adjust their earnings rapidly, over 38% do not, and instead take several years to adjust. We propose that heterogeneity in firm labor demand plays a key role in generating the observed differences in the speed of workers' earnings responses and predict that adjustment will be quickest at growing firms. We test and find support for these demand-side effects in our linked employer-employee data.

Keywords: labor supply responses to taxation; earnings adjustment frictions; labor demand (search for similar items in EconPapers)
JEL-codes: H24 H31 J22 J23 (search for similar items in EconPapers)
Pages: 99 pages
Date: 2020-12
New Economics Papers: this item is included in nep-lma and nep-pbe
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (8)

Published - published in: Journal of Labor Economics, 2024, 42 (3), 793–835

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Journal Article: The Speed of Earnings Responses to Taxation and the Role of Firm Labor Demand (2024)
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