The Impact of Labor Taxes on Labor Supply: An International Perspective »

Richard Rogerson is the Rondthaler Professor of Economics at the W.P. Carey School of Business at Arizona State University.

As the Bush-era tax cuts are set to expire in 2010, ambitious health care legislation is moving through Congress, and entitlement programs are growing at unsustainable rates, U.S. policymakers face important questions about the optimal size and scope of federal spending. The federal government finances its spending through labor taxes, including taxes on income, payroll, and consumption-taxes that generate significant disincentives for employment. In Taxes, Transfers, and Labor Supply: An International Perspective, Richard Rogerson contends that the unintended consequences of increased labor taxes would be too large for policymakers to ignore. Rogerson compares fifty years of time series data from the United States and fourteen other OECD countries. He finds that a 10 percentage point increase in the tax rate on labor leads to a 10 to 15 percent decrease in hours of work. Even a 5 percent decrease in hours worked would mean a decline in labor market productivity equating to a serious recession. But, whereas recessions are temporary, changes in government spending patterns have permanent repercussions. Although government spending provides citizens with many important benefits, these benefits must be weighed against the disincentivizing effects of increased labor taxes. Policymakers who fail to account for this decrease in labor productivity risk expanding government programs beyond the economy's ability to support them.

List of Illustrations ix

Preface xi

Introduction 1

1 Labor Taxes and Hours of Work: Some Theory 10

The Textbook Model of Labor Supply 11

A Diagrammatic Representation of the Consumption-Leisure Trade-Off 14

Income and Substitution Effects 16

Analyzing Tax Policy 18

The Social Cost of Higher Taxes 22

The Laffer Curve 23

Additional Tax Instruments 24

Additional Spending Policies 26

Summary 27

2 Labor Taxes and Hours of Work: Where to Look for Evidence? 28

How Do We Know What We Think We Know? 28

Experimental Data from the Economy 32

Summary 35

3 Taxes, Government Spending, and Hours of Work in the United States 36

U.S. Tax Rates on Labor 36

Properties of Government Spending in the United States 43

Hours of Work in the United States 46

Summary 50

4 What We Learn from the U.S. Experience 51

The Missing Factor 52

Home Production and Labor Supply 54

Changes in Home and Market Work 57

Reassessing the Relationship between Labor Taxes and Market Work 62

Summary 64

5 What We Learn from the Experience of Other Countries 65

Labor Taxes in the OECD 65

Hours Worked in the OECD 67

Changes in Taxes and Changes in Hours of Work 68

Cultural Differences 71

Other Explanations for Differences in Hours Worked 72

Supporting Evidence: Home versus Market Production 80

The Netherlands 82

Summary 84

6 Understanding Scandinavia 86

The Importance of How the Government Spends 87

Summary 93

Conclusion 94

Appendix 98

Notes 105

References 109

About the Author 113