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Micro vs Macro Labor Supply Elasticities: The Role of Dynamic Returns to Effort

Author

Listed:
  • Henrik Kleven
  • Claus Thustrup Kreiner
  • Kristian Larsen
  • Jakob Egholt Søgaard
Abstract
A key contention in economics is the discrepancy between micro and macro elasticities of labor supply with respect to marginal tax rates. We revisit this question, focusing on the role of dynamic returns to effort among top earners. We develop a new model of earnings responses to taxes in the presence of dynamic returns. In this model, the returns to effort are delayed and mediated by job switches such as promotions within firms or movements between firms. Short-run micro elasticities are attenuated relative to the true long-run macro elasticity. We proceed by providing two main empirical analyses using rich administrative data from Denmark. The first part presents descriptive evidence on earnings and hours-worked patterns over the lifecycle that confirm the predictions of the theoretical model. The second part presents quasi-experimental evidence on earnings responses to taxes using discrete job switches. The empirical strategy is informed by the theoretical model, according to which job switches can be used to (partially) identify the macro elasticity of labor supply. The evidence shows that, at the top of the distribution, macro elasticities are much larger than micro elasticities due to dynamic compensation effects.

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  • Henrik Kleven & Claus Thustrup Kreiner & Kristian Larsen & Jakob Egholt Søgaard, 2023. "Micro vs Macro Labor Supply Elasticities: The Role of Dynamic Returns to Effort," NBER Working Papers 31549, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:31549
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    Cited by:

    1. Selin, Håkan, 2024. "Taxing dividends in a dual income tax system - The Nordic experience with the income splitting rules," Working Paper Series 2024:20, IFAU - Institute for Evaluation of Labour Market and Education Policy.
    2. Kleven, Henrik, 2024. "The EITC and the extensive margin: A reappraisal," Journal of Public Economics, Elsevier, vol. 236(C).

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    More about this item

    JEL classification:

    • C1 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General
    • D6 - Microeconomics - - Welfare Economics
    • E6 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook
    • H2 - Public Economics - - Taxation, Subsidies, and Revenue
    • H3 - Public Economics - - Fiscal Policies and Behavior of Economic Agents
    • J2 - Labor and Demographic Economics - - Demand and Supply of Labor
    • J3 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs

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