DP2367 Iceland's Natural Experiment in Supply-Side Economics

Author(s): Marco Bianchi, Björn R Gudmundsson, Gylfi Zoega
Publication Date: January 2000
Keyword(s): Labour Supply, Supply-Side Economics
JEL(s): E65, J22
Programme Areas: Labour Economics
Link to this Page: www.cepr.org/active/publications/discussion_papers/dp.php?dpno=2367

The move to a pay-as-you-earn income tax system in Iceland in 1987-1988 made income earned in 1987 tax-free. Using a sample of 9,274 individuals for the years 1986, 1987 and 1988, we calculate the labour-supply response of this change and find that total labour supply rose by 6.7% in 1987 over the average of 1986 and 1988 when we correct for entry in 1988. This consists of an 8.6% increase in weeks supplied by those already in the labour market in 1986 and a 1.9% decline due to entry/exit. The elasticity of weeks worked to the rise in after-tax wages was 0.41 for men and 0.11 for women. While the participation rate of women increased somewhat in our sample, participation by men fell.