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Tax Law Changes, Income Shifting and Measured Wage Inequality: Evidence from India

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  • Jagadeesh Sivadasan
  • Joel Slemrod

Abstract

We use a large dataset covering all registered plants in the manufacturing sector in India over the period 1986 to 1995 to examine the effects of a 1992 income tax law change that eliminated the double taxation of wages paid to partners in partnership firms. This tax law change provides a unique opportunity to identify the effects of tax policy changes on firm behavior in a developing country context. Since the change provided incentives for shifting income from wages to profits, it also has important implications for certain measures of wage inequality. We find an immediate and pervasive response by partnership firms to the tax law change, reflected in a significant shifting of income from profits to managerial wages. Since about 50 percent of registered manufacturing plants are incorporated in the form of partnerships (including most family-run businesses), income shifting by these firms could have a significant impact on measured wage inequality. We find a sizeable jump in the mean and median relative wage of skilled workers (which includes managers and partners) following the tax law change in 1992. This sudden increase in measured wage inequality follows major trade liberalization and deregulation reforms announced earlier (in July 1991). We find that the income shifting induced by the tax law change explains almost all of the observed increase in measured wage inequality following these reforms. This finding is robust to inclusion of controls for a number of other potential sources of post-liberalization increases in wage inequality. Our results show that firms respond strongly to tax incentives for income shifting, and highlight the need to control for the potential effects of tax incentives in studies of wage inequality.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 12240.

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Date of creation: May 2006
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Handle: RePEc:nbr:nberwo:12240

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Citations

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Cited by:
  1. Anne Lauringson, 2011. "Unemployment Benefits In A Period Of Crisis: The Effect On Unemployment Duration," University of Tartu - Faculty of Economics and Business Administration Working Paper Series 82, Faculty of Economics and Business Administration, University of Tartu (Estonia).
  2. Jaan Masso & Jaanika Meriküll & Priit Vahter, 2011. "Gross Profit Taxation Versus Distributed Profit Taxation And Firm Performance: Effects Of Estonia’S Corporate Income Tax Reform," University of Tartu - Faculty of Economics and Business Administration Working Paper Series 81, Faculty of Economics and Business Administration, University of Tartu (Estonia).
  3. Burkhauser, Richard V. & Feng, Shuaizhang & Jenkins, Stephen P. & Larrimore, Jeff, 2009. "Recent Trends in Top Income Shares in the USA: Reconciling Estimates from March CPS and IRS Tax Return Data," IZA Discussion Papers 4426, Institute for the Study of Labor (IZA).
  4. Kazuki Onji, 2008. "The Response of Firms to Eligibility Thresholds : Evidence from the Japanese Value-Added Tax," Finance Working Papers 21965, East Asian Bureau of Economic Research.
  5. Peter Egger & Christian Keuschnigg & Hannes Winner, 2009. "Incorporation and Taxation: Theory and Firm-level Evidence," CESifo Working Paper Series 2685, CESifo Group Munich.
  6. Jarkko Harju & Tuomas Matikka, 2013. "Entrepreneurs and income-shifting: Empirical evidence from a Finnish tax reform," Working Papers 43, Government Institute for Economic Research Finland (VATT).
  7. Jarkko Harju & Tuomas Kosonen, 2012. "The Impact of Tax Incentives on the Economic Activity of Entrepreneurs," NBER Working Papers 18442, National Bureau of Economic Research, Inc.
  8. Masso, Jaan & Meriküll, Jaanika & Vahter, Priit, 2013. "Shift from gross profit taxation to distributed profit taxation: Are there effects on firms?," Journal of Comparative Economics, Elsevier, vol. 41(4), pages 1092-1105.
  9. Menon, Nidhiya & Rodgers, Yana van der Meulen, 2009. "International Trade and the Gender Wage Gap: New Evidence from India's Manufacturing Sector," World Development, Elsevier, vol. 37(5), pages 965-981, May.
  10. Christian Keuschnigg & Peter Egger & Hannes Winner, 2010. "A Theory of Taxation and Incorporation," University of St. Gallen Department of Economics working paper series 2010 2010-25, Department of Economics, University of St. Gallen.
  11. Keuschnigg, Christian & Egger, Peter & Winner, Hannes, 2011. "Taxation and Incorporation," Annual Conference 2011 (Frankfurt, Main): The Order of the World Economy - Lessons from the Crisis 48729, Verein für Socialpolitik / German Economic Association.

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