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Income taxes, compensating differentials, and occupational choice: how taxes distort the wage-amenity decision

Author

Listed:
  • David Powell
  • Hui Shan

Abstract

The link between taxes and occupational choices is central for understanding the welfare impacts of income taxes. Just as taxes distort the labor-leisure decision, they also distort the wage-amenity decision. Yet, there are no estimates of the full response on this margin. When tax rates increase, workers favor jobs with lower wages and more non-taxable amenities. We introduce a two-step methodology which uses compensating differentials to characterize the tax elasticity of occupational choice. We estimate a significant compensated elasticity of 0.05, implying that a 10% increase in the net-of-tax rate causes workers to change to a 0.5% higher wage job.

Suggested Citation

  • David Powell & Hui Shan, 2010. "Income taxes, compensating differentials, and occupational choice: how taxes distort the wage-amenity decision," Finance and Economics Discussion Series 2010-04, Board of Governors of the Federal Reserve System (U.S.).
    • Handle: RePEc:fip:fedgfe:2010-04
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    Cited by:

    1. Cai, Jie & Stoyanov, Andrey, 2023. "Progressive income tax and comparative advantage in trade," Economic Modelling, Elsevier, vol. 129(C).
    2. Arnaud Dupuy & Alfred Galichon & Sonia Jaffe & Scott Duke Kominers, 2020. "Taxation In Matching Markets," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 61(4), pages 1591-1634, November.
    3. Alpert, Abby & Powell, David, 2014. "Estimating Intensive and Extensive Tax Responsiveness: Do Older Workers Respond to Income Taxes?," Working Papers 987-1, RAND Corporation.
    4. Kohl, Miriam & Richter, Philipp M., 2023. "Unilateral tax policy in the open economy," Journal of International Economics, Elsevier, vol. 145(C).
    5. Abby Alpert & David Powell, 2014. "Estimating Intensive and Extensive Tax Responsiveness Do Older Workers Respond to Income Taxes?," Working Papers WR-987-1, RAND Corporation.
    6. Erwin Ooghe, 2020. "Conditional Earnings Subsidies for Low Earners," Scandinavian Journal of Economics, Wiley Blackwell, vol. 122(2), pages 524-552, April.
    7. David Powell, 2011. "Heterogeneity in Income Tax Incidence Are the Wages of Dangerous Jobs More Responsive to Tax Changes than the Wages of Safe Jobs?," Working Papers WR-706-1, RAND Corporation.
    8. Ingo E. Isphording, 2010. "Risky Business – The Role of Individual Risk Attitudes in Occupational Choice," Ruhr Economic Papers 0187, Rheinisch-Westfälisches Institut für Wirtschaftsforschung, Ruhr-Universität Bochum, Universität Dortmund, Universität Duisburg-Essen.
    9. Christian Keuschnigg & Thomas Davoine, 2010. "Flexicurity and Job Reallocation," University of St. Gallen Department of Economics working paper series 2010 2010-11, Department of Economics, University of St. Gallen.
    10. Isphording, Ingo E., 2010. "Risky Business – The Role of Individual Risk Attitudes in Occupational Choice," Ruhr Economic Papers 187, RWI - Leibniz-Institut für Wirtschaftsforschung, Ruhr-University Bochum, TU Dortmund University, University of Duisburg-Essen.
    11. Sieuwerd Gaastra, 2020. "Personal Income Taxation and College Major Choice: A Case Study of the 1986 Tax Reform Act," Public Finance Review, , vol. 48(1), pages 3-42, January.
    12. Joseph Michael Newhard, 2018. "The effect of equalizing differences on tax-price: explaining patterns of political support across industries," Constitutional Political Economy, Springer, vol. 29(3), pages 281-302, September.
    13. Morris M. Kleiner & Evan J. Soltas, 2019. "A Welfare Analysis of Occupational Licensing in U.S. States," Staff Report 590, Federal Reserve Bank of Minneapolis.
    14. Michael Gmeiner & Robert Gmeiner, 2022. "Regulation Enforcement," Journal of Labor Research, Springer, vol. 43(2), pages 163-202, June.
    15. Erwin Ooghe, 2015. "Wage policies, employment, and redistributive efficiency," Working Papers of Department of Economics, Leuven 504880, KU Leuven, Faculty of Economics and Business (FEB), Department of Economics, Leuven.
    16. Kohl, Miriam, 2020. "Redistribution, selection, and trade," Journal of International Economics, Elsevier, vol. 122(C).
    17. Aaron Klein & Justin Schardin, 2025. "Credit card rewards subsidize the wealthy," Journal of Policy Analysis and Management, John Wiley & Sons, Ltd., vol. 44(3), pages 1099-1106, June.
    18. Abby Alpert & David Powell, 2012. "Tax Elasticity of Labor Earnings for Older Individuals," Working Papers wp272, University of Michigan, Michigan Retirement Research Center.
    19. David Powell, 2012. "Compensating Differentials and Income Taxes: Are the Wages of Dangerous Jobs More Responsive to Tax Changes than the Wages of Safe Jobs?," Journal of Human Resources, University of Wisconsin Press, vol. 47(4), pages 1023-1054.
    20. Jason Sockin, 2022. "Show Me the Amenity: Are Higher-Paying Firms Better All Around?," CESifo Working Paper Series 9842, CESifo.
    21. Thomas Davoine & Christian Keuschnigg, 2015. "Flexicurity, Taxes and Job Reallocation," CESifo Working Paper Series 5302, CESifo.
    22. David Powell, 2019. "The Distortionary Effects of the Health Insurance Tax Exclusion," American Journal of Health Economics, University of Chicago Press, vol. 5(4), pages 428-464, Fall.

    More about this item

    Keywords

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    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
    • J24 - Labor and Demographic Economics - - Demand and Supply of Labor - - - Human Capital; Skills; Occupational Choice; Labor Productivity
    • J31 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Wage Level and Structure; Wage Differentials

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