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Tax Effects on Work Activity, Industry Mix and Shadow Economy Size: Evidence from Rich-Country Comparisons

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Steven J. Davis
Magnus Henrekson

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Abstract

Guided by a simple theory of task assignment and time allocation, we investigate the long run response to national differences in tax rates on labor income, payrolls and consumption. The theory implies that higher tax rates reduce work time in the market sector, increase the size of the shadow economy, alter the industry mix of market activity, and twist labor demand in a way that amplifies negative effects on market work and concentrates effects on the less skilled. We also describe conditions whereby cross-country OLS regressions yield unbiased estimates of the total effect of taxes, inclusive of indirect effects that work through government spending responses to tax revenues. Regressions on rich-country samples in the mid 1990s indicate that a unit standard deviation tax rate difference of 12.8 percentage points leads to 122 fewer market work hours per adult per year, a drop of 4.9 percentage points in the employment-population ratio, and a rise in the shadow economy equal to 3.8 percent of GDP. It also leads to 10 to 30 percent lower employment and value added shares in (a) retail trade and repairs, (b) eating, drinking and lodging, and (c) a broader industry group that includes wholesale and motor trade.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 10509.

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Date of creation: May 2004
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Handle: RePEc:nbr:nberwo:10509

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Find related papers by JEL classification:
D13 - Microeconomics - - Household Behavior - - - Household Production and Intrahouse Allocation
H24 - Public Economics - - Taxation, Subsidies, and Revenue - - - Personal Income and Other Nonbusiness Taxes and Subsidies

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Full references

Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Richard Rogerson, 2006. "Understanding Differences in Hours Worked," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 9(3), pages 365-409, July. [Downloadable!] (restricted)
  2. Edward C. Prescott, 2003. "Why do Americans work so much more than Europeans?," Staff Report 321, Federal Reserve Bank of Minneapolis. [Downloadable!]
    Other versions:
  3. Luigi Bonatti, 2007. "Home production, labor taxation and trade account," Department of Economics Working Papers 0715, Department of Economics, University of Trento, Italia. [Downloadable!]
  4. Tito Boeri & Pietro Garibaldi, 2006. "Shadow Sorting," Carlo Alberto Notebooks 10, Collegio Carlo Alberto. [Downloadable!]
    Other versions:
  5. Alison Booth & Melvyn Coles, 2007. "The Impact Of Fiscal Policy On Labor Supply And Education In An Economy With Household And Market Production," CAMA Working Papers 2007-08, Australian National University, Centre for Applied Macroeconomic Analysis. [Downloadable!]
    Other versions:
  6. C. Bianchi & M. Menegatti, 2007. "Rules versus discretion in fiscal policy," Economics Department Working Papers 2007-EP05, Department of Economics, Parma University (Italy). [Downloadable!]
  7. Richard Rogerson, 2007. "Structural Transformation and the Deterioration of European Labor Market Outcomes," NBER Working Papers 12889, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  8. Henrekson, Magnus, 2002. "Entrepreneurship: A Weak Link in the Welfare State," Working Paper Series in Economics and Finance 518, Stockholm School of Economics, revised 04 Mar 2005. [Downloadable!]
    Other versions:
  9. Luigi Bonatti, 2007. "Evolution of preferences and cross-country differences in time devoted to market work," Department of Economics Working Papers 0719, Department of Economics, University of Trento, Italia. [Downloadable!]
  10. Lee Ohanian & Andrea Raffo & Richard Rogerson, 2006. "Long-term changes in labor supply and taxes: evidence from OECD countries, 1956-2004," Research Working Paper RWP 06-16, Federal Reserve Bank of Kansas City. [Downloadable!]
    Other versions:
  11. Raj Chetty, 2006. "A Bound on Risk Aversion Using Labor Supply Elasticities," NBER Working Papers 12067, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  12. Giulia Faggio & Stephen Nickell, 2006. "Patterns of Work Across the OECD," CEP Discussion Papers dp0730, Centre for Economic Performance, LSE. [Downloadable!]
    Other versions:
  13. Richard Rogerson, 2007. "Taxation and Market Work: Is Scandinavia an Outlier?," NBER Working Papers 12890, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  14. Steven J. Davis & Luis Rivera-Batiz, 2005. "The Climate for Business Development and Employment Growth in Puerto Rico," NBER Working Papers 11679, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  15. Hannu Piekkola, 2006. "Tax cuts and employment: Evidence from Finnish linked employer-employee data," Discussion Papers 1041, The Research Institute of the Finnish Economy. [Downloadable!]
  16. Alberto Alesina & Edward L. Glaeser & Bruce Sacerdote, 2005. "Work and Leisure in the U.S. and Europe: Why So Different?," NBER Working Papers 11278, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  17. Andrew Kashdan and Daniel B. Klein, 2006. "Assume the Positional: Comment on Robert Frank," Econ Journal Watch, Atlas Economic Research Foundation, vol. 3(3), pages 412-434, September. [Downloadable!]
  18. Lei Fang & Richard Rogerson, 2007. "Product Market Regulation and Market Work: A Benchmark Analysis," NBER Working Papers 12891, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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