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Adjustment Costs, Firm Responses, and Labor Supply Elasticities: Evidence from Danish Tax Records

  • Raj Chetty

    (Harvard University)

  • John N. Friedman

    (Harvard University)

  • Tore Olsen

    (Harvard University)

  • Luigi Pistaferri

    (Harvard University)

We show that the effects of taxes on labor supply are shaped by interactions between adjustment costs for workers and hours constraints set by firms. We develop a model in which firms post job offers characterized by an hours requirement and workers pay search costs to find jobs. In this model, micro elasticities are smaller than macro elasticities because they do not account for adjustment costs and firm responses. We present evidence supporting three predictions of the model by analyzing bunching at kinks using the universe of tax records in Denmark. First, larger kinks generate larger taxable income elasticities because they are more likely to overcome search costs. Second, kinks that apply to a larger group of workers generate larger elasticities because they induce changes in hours constraints. Third, firms tailor job offers to match workers.aggregate tax preferences in equilibrium. Calibrating our model to match these empirical findings, we obtain a lower bound on the intensive-margin macro elasticity of 0:34, an order of magnitude larger than the estimates obtained using standard microeconometric methods for wage earners in our data.

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Paper provided by University of Copenhagen. Department of Economics. Centre for Applied Microeconometrics in its series CAM Working Papers with number 2010-03.

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Length: 41 pages
Date of creation: Mar 2010
Date of revision:
Handle: RePEc:kud:kuieca:2010_03
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