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Effects of Permanent and Transitory Tax Changes in a Life-Cycle Labor Supply Model with Human Capital

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  • Michael P. Keane

    () (University of Oxford)

Abstract

I examine the effect of labor income taxation in life-cycle models where work experience builds human capital. In this case, the wage no longer equals the opportunity cost of time – which is, instead, the wage plus returns to work experience. This has a number of interesting consequences: First, the data appear consistent with much larger labor supply elasticities than most prior work suggests. Second, contrary to conventional wisdom, permanent tax changes can have larger effects on current labor supply than temporary tax changes. Third, human capital dampens the response of young workers to transitory tax changes, while causing responses to both permanent and transitory tax changes to increase with age. Fourth, human capital amplifies the labor supply response to permanent tax changes in the long-run, as a permanent tax reduces the rate of human capital accumulation (reducing worker productivity).

Suggested Citation

  • Michael P. Keane, 2016. "Effects of Permanent and Transitory Tax Changes in a Life-Cycle Labor Supply Model with Human Capital," Economics Papers 2016-W06, Economics Group, Nuffield College, University of Oxford.
  • Handle: RePEc:nuf:econwp:1606
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    References listed on IDEAS

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    Cited by:

    1. Matteo Bobba & Luca Flabbi & Santiago Levy & Mauricio Tejada, 2019. "Labor Market Search, Informality, and On-The-Job Human Capital Accumulation," ILADES-UAH Working Papers inv326, Universidad Alberto Hurtado/School of Economics and Business.
    2. Zhiyang Jia & Trine E. Vattø, 2016. "The path of labor supply adjustment. Sources of lagged responses to tax-benefit reforms," Discussion Papers 854, Statistics Norway, Research Department.

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