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Labor Supply Responses and Adjustment Frictions: A Tax-Free Year in Iceland

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  • Jósef Sigurdsson

Abstract

Labor income earned in Iceland in 1987 went untaxed. I use this episode to study labor supply responses to temporary wage changes. Using a population-wide dataset of earnings and working time and two identification strategies, I estimate intensive and extensive margin Frisch elasticities of 0.4 and 0.09, respectively. Workers with the ability to adjust drive these average responses: extensive margin by young and close-to-retirement cohorts and intensive margin responses by workers in temporally flexible jobs, though secondary jobs contribute to one-tenth of the response. The results suggest that adjustment frictions may similarly explain differences in elasticities within and across countries.

Suggested Citation

  • Jósef Sigurdsson, 2025. "Labor Supply Responses and Adjustment Frictions: A Tax-Free Year in Iceland," American Economic Journal: Economic Policy, American Economic Association, vol. 17(4), pages 30-71, November.
    • Handle: RePEc:aea:aejpol:v:17:y:2025:i:4:p:30-71
    DOI: 10.1257/pol.20220386
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    More about this item

    JEL classification:

    • H24 - Public Economics - - Taxation, Subsidies, and Revenue - - - Personal Income and Other Nonbusiness Taxes and Subsidies
    • H31 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - Household
    • J22 - Labor and Demographic Economics - - Demand and Supply of Labor - - - Time Allocation and Labor Supply

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