Working Paper: CEPR ID: DP9275
Authors: Claus Thustrup Kreiner; Jakob Roland Munch; Hans Jørgen Whitta-Jacobsen
Abstract: Inspired by Hayek (1945), we study the distortionary effects of taxation on labor mobility and the long run allocation of labor across different profitable opportunities. These effects are not well detected by the methods applied in the large public finance literature estimating the elasticity of taxable income and quantifying the welfare loss from taxation. Our analysis builds on a standard search theoretic framework where workers are continually seeking better paid jobs, but are also fired from time to time because of economic development and productivity shocks. We incorporate non-linear taxation into this setting and estimate the structural parameters of the model using employer-employee register based data for the full Danish population of workers and workplaces for the years 2004-2006. Our results indicate that along the intensive margin the Danish taxation generates an overall efficiency loss corresponding to a 12 percent reduction in GDP. It is possible to reap 4/5 of this potential efficiency gain by going from a high-tax Scandinavian system to a level of taxation in line with low-tax OECD countries such as the United States. The tax-responsiveness of labor mobility and allocationcorresponds to an elasticity of taxable income with respect to the net-of-tax rate in the range 0.15-0.3.
Keywords: Elasticity of Taxable Income; Labor Mobility; Tax Distortions
JEL Codes: H21
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Danish taxation (H29) | 12% reduction in GDP (F69) |
| transitioning from high-tax Scandinavian system to lower-tax OECD level (H29) | recover up to 45% of efficiency gain (D61) |
| elasticity of taxable income with respect to net-of-tax rate (H32) | measurable responsiveness of labor mobility to tax changes (J69) |
| replacing current tax system with flat tax of 30% (H29) | increase GDP by 20% (E20) |
| replacing current tax system with flat tax of 30% (H29) | yield a welfare gain of 10% relative to GDP (D69) |
| degree of self-financing from behavioral responses (G41) | approximately 87% of mechanical loss in tax revenue (H26) |
| taxation (H20) | distort labor mobility and allocation (J69) |