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Policy Thresholds as Growth Barriers: Theory and Evidence from a Payroll Tax Notch

Author

Listed:
  • Sami Jysmä
  • Youssef Benzarti
  • Jarkko Harju

Abstract

Discrete policy thresholds are pervasive in tax and regulatory systems and can substantially distort behavior. We show that notches acting as barriers to mobility within a distribution generate distortions extending far beyond the threshold. The same mechanism biases conventional difference-in-differences estimators, and we propose a new methodology to recover causal effects. Applying the method to the abolition of a size-based payroll tax notch, we find that the notch reduced the number of firms above the threshold by 18 percent and lowered treated firms' employment, capital stock, and value added by 10 percent, whereas conventional difference-in-differences estimates imply negligible effects.

Suggested Citation

  • Sami Jysmä & Youssef Benzarti & Jarkko Harju, 2026. "Policy Thresholds as Growth Barriers: Theory and Evidence from a Payroll Tax Notch," CESifo Working Paper Series 12821, CESifo.
    • Handle: RePEc:ces:ceswps:_12821
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    References listed on IDEAS

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    1. Emmanuel Saez & Benjamin Schoefer & David Seim, 2019. "Payroll Taxes, Firm Behavior, and Rent Sharing: Evidence from a Young Workers' Tax Cut in Sweden," American Economic Review, American Economic Association, vol. 109(5), pages 1717-1763, May.
    2. Clément de Chaisemartin & Xavier D’Haultfœuille, 2023. "Two-way fixed effects and differences-in-differences with heterogeneous treatment effects: a survey," The Econometrics Journal, Royal Economic Society, vol. 26(3), pages 1-30.
    3. Henrik J. Kleven & Mazhar Waseem, 2013. "Using Notches to Uncover Optimization Frictions and Structural Elasticities: Theory and Evidence from Pakistan," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 128(2), pages 669-723.
    4. Gruber, Jon & Saez, Emmanuel, 2002. "The elasticity of taxable income: evidence and implications," Journal of Public Economics, Elsevier, vol. 84(1), pages 1-32, April.
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    Keywords

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    JEL classification:

    • H30 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - General
    • C01 - Mathematical and Quantitative Methods - - General - - - Econometrics
    • H25 - Public Economics - - Taxation, Subsidies, and Revenue - - - Business Taxes and Subsidies

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