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The Wage Response to a Reduction in Income Tax Rates: The 2003–2009 Tax Reform in Israel

Author

Listed:
  • Sophia Igdalov

    (Bank of Israel)

  • Roni Frish

    (Bank of Israel)

  • Noam Zussman

    (Bank of Israel)

Abstract

This study examines the effect of a tax reform on the incentive to work. The reform implemented in Israel between 2003 and 2009 lowered the marginal income tax of individuals by 7–17 percentage points. The effect of the reform on the incentive to work is estimated by comparing the change in gross wage between individuals who experienced a marked reduction of their marginal tax and others who experienced small reduction. We used panel data from the Income Tax Authority, including wages and tax payments of employees, and merged them with data from Labor Force Surveys. We found that in the business sector, the elasticity of the gross reported wage relative to the net-of-tax rate (one minus the effective marginal direct tax rate) is about 0.1, within the range of elasticities found in similar studies. Between 2002 and 2009, the net-of-tax rate increased by about 13 percent; Therefore, given the estimated elasticity, the total reported gross wage in the business sector increased by approximately 1.1 percent. The three lowest quintiles did not react at all to the reduction in tax rates, but the elasticity increased with wages, reaching about 0.4 in the upper quintile. We did not find statistically significant differences in elasticity b gender, ethnicity or education. We also did not find a statistically significant reaction to the reform among public sector workers.

Suggested Citation

  • Sophia Igdalov & Roni Frish & Noam Zussman, 2017. "The Wage Response to a Reduction in Income Tax Rates: The 2003–2009 Tax Reform in Israel," Bank of Israel Working Papers 2017.14, Bank of Israel.
    • Handle: RePEc:boi:wpaper:2017.14
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    References listed on IDEAS

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    2. Hazan, Moshe & Tsur, Shay, 2019. "Why is Labor Productivity in Israel so Low?," CEPR Discussion Papers 14011, C.E.P.R. Discussion Papers.

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