DP9275 Taxation and the Long Run Allocation of Labor: Theory and Danish Evidence

Author(s): Claus T. Kreiner, Jakob Roland Munch, Hans-Jørgen Whitta-Jacobson
Publication Date: January 2013
Keyword(s): elasticity of taxable income, labor mobility, tax distortions
JEL(s): H21
Programme Areas: Public Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=9275

Inspired by Hayek (1945), we study the distortionary effects of taxation on labor mobility and the long run allocation of labor across different profitable opportunities. These effects are not well detected by the methods applied in the large public finance literature estimating the elasticity of taxable income and quantifying the welfare loss from taxation. Our analysis builds on a standard search theoretic framework where workers are continually seeking better paid jobs, but are also fired from time to time because of economic development and productivity shocks. We incorporate non-linear taxation into this setting and estimate the structural parameters of the model using employer-employee register based data for the full Danish population of workers and workplaces for the years 2004-2006. Our results indicate that along the intensive margin the Danish taxation generates an overall efficiency loss corresponding to a 12 percent reduction in GDP. It is possible to reap 4/5 of this potential efficiency gain by going from a high-tax Scandinavian system to a level of taxation in line with low-tax OECD countries such as the United States. The tax-responsiveness of labor mobility and allocation corresponds to an elasticity of taxable income with respect to the net-of-tax rate in the range 0.15-0.3.