Personal Income Tax: Incentive or Disincentive to Work Effort?

This paper investigates the implications of an exogenous increase (decrease) in the income tax schedule for hours worked per employee and per self-employed in a general equilibrium model. The model is estimated for France, Italy, Spain and Portugal using the gmm estimation technique. Steady-state analysis and econometric estimates show that tax withholding provisions diversify the response of employees and the self-employed to adjustments in the direct tax system. Among the results is that, in the presence (absence) of tax withholding provisions, the labor supply curve may become downward (upward) sloping. Thus, the argument advanced by those who advocate the implementation of a strategy aiming at reducing taxes on labor in order to increase incentives to work need to be carefully reconsidered.