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The path of labor supply adjustment. Sources of lagged responses to tax-benefit reforms

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The standard static labor supply model ignores that it takes time for individuals to adjust to a taxbenefit reform. A labor supply decision model is developed that allows for lagged responses in terms of state dependence, stemming from preferences, labor market constraints and adjustment costs. The parameters of the model are estimated using panel data on working hours for Norwegian females. We find evidence of all three sources of state dependence, with adjustment costs as the most dominant component. When using the model to simulate the path of adjustment to a general tax cut, we find that state dependence brings down responses to only one third of the estimated full effect in the first year. The females reach the proximity of the full effect after about seven years.

Suggested Citation

  • 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.
  • Handle: RePEc:ssb:dispap:854
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    Keywords

    labor supply; path of adjustment; state dependence; adjustment costs; discrete choice model; tax-benefit microsimulation;

    JEL classification:

    • C35 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Discrete Regression and Qualitative Choice Models; Discrete Regressors; Proportions
    • C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
    • 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

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