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Micro vs Macro Labor Supply Elasticities: The Role of Dynamic Returns to Effort

Author

Listed:
  • Henrik Kleven

    (Princeton University, NBER, and CEBI)

  • Claus Kreiner

    (University of Copenhagen and CEBI)

  • Kristian Larsen

    (University of Copenhagen and CEBI)

  • Jakob Søgaard

    (University of Copenhagen and CEBI)

Abstract

A key contention in economics is the discrepancy between micro and macro elasticities of labor supply with respect to marginal tax rates. We revisit this question, focusing on the role of dynamic returns to effort among top earners. We develop a new model of earnings responses to taxes in the presence of dynamic returns. In this model, the returns to effort are delayed and mediated by job switches such as promotions within firms or movements between firms. Short-run micro elasticities are attenuated relative to the true long-run macro elasticity. We proceed by providing two main empirical analyses using rich administrative data from Denmark. The first part presents descriptive evidence on earnings and hours-worked patterns over the lifecycle that confirm the predictions of the theoretical model. The second part presents quasi-experimental evidence on earnings responses to taxes using discrete job switches. The empirical strategy is informed by the theoretical model, according to which job switches can be used to (partially) identify the macro elasticity of labor supply. The evidence shows that, at the top of the distribution, macro elasticities are much larger than micro elasticities due to dynamic compensation effects.

Suggested Citation

  • Henrik Kleven & Claus Kreiner & Kristian Larsen & Jakob Søgaard, 2023. "Micro vs Macro Labor Supply Elasticities: The Role of Dynamic Returns to Effort," Working Papers 2023-15, Princeton University. Economics Department..
    • Handle: RePEc:pri:econom:2023-15
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    Cited by:

    1. Kazuhiko Sumiya & Jesper Bagger, 2025. "Income Taxes, Gross Hourly Wages, and the Anatomy of Behavioral Responses: Evidence from a Danish Tax Reform," Papers 2510.16483, arXiv.org.
    2. Selin Håkan, 2024. "Taxing Dividends in a Dual Income Tax System: The Nordic Experience with the Income Splitting Rules," Nordic Tax Journal, Sciendo, vol. 2024(s1), pages 83-94.
    3. Spencer Bastani, 2025. "The marginal value of public funds: a brief guide and application to tax policy," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 32(4), pages 919-956, August.
    4. Kleven, Henrik, 2024. "The EITC and the extensive margin: A reappraisal," Journal of Public Economics, Elsevier, vol. 236(C).

    More about this item

    Keywords

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    JEL classification:

    • J20 - Labor and Demographic Economics - - Demand and Supply of Labor - - - General
    • J22 - Labor and Demographic Economics - - Demand and Supply of Labor - - - Time Allocation and Labor Supply

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