Labour responsiveness to income tax changes: empirical evidence from a DID analysis of an income tax treatment in Italy

This paper uses an Italian income tax treatment occurred in 2006/7 as a quasi-natural tax experiment and offers some fresh empirical evidence on how labour supply responds to exogenous income tax hikes. The specific features of the Italian tax measures, namely homogeneity and contemporaneity of the treatment across Italian regions, allow us to adopt the identification strategy of the two-way fixed effect (TWFE) panel data difference-in-differences (DID) model and to define the correct statistical framework of the study. We find that income tax hikes cause extensive negative adjustments of various response variables measuring the supply of labour services offered by treated taxpayers. DID estimated coefficients indicate that supply adjustments are significant, fast, and strong but not long-time lasting. Estimated time effects permit to evaluate the time impact of the tax measures and to conduct a dynamical policy evaluation of the tax hikes. We also show that treated families reduce in a similar manner their consumption with respect to families in the control groups and that analogous adjustment responses to income tax hikes characterise the growth of real per capita regional GDP. Altogether, estimates provide an overall view of the labour, consumption, and real growth effects of the income tax hikes. Results from DID estimations are further evaluated in comparison with the spatial–temporal patterns observed for every response variable in treated and untreated regions.