Sunday, April 29, 2007

What I've been reading

A fascinating new paper by Richard Rogerson and Johanna Wallenius examines how work effort responds to tax rates.

The paper emphasizes the distinction between the intensive margin and the extensive margin. The intensive margin refers to how many hours an employed person chooses to work. The extensive margin refers to a person's decision whether to work at all. (I personally dislike these terms, because I can never remember which is which.)

Here is the paper's conclusion:

In this paper we develop a general equilibrium life cycle model of labor supply that incorporates both intensive and extensive margins of labor supply....Our analysis produces four main findings. First, macro elasticities and micro elasticities are virtually unrelated: a factor 25 difference in micro elasticities is associated with only a thirty percent change in the associated macro elasticities. Second, macro elasticities are large—in the range of 2.3 − 3.0. Third, in our model with variation in either productivity or disutility of work over the life cycle, tax and transfer programs necessarily imply that higher taxes lead to less work on both the extensive and intensive margin. Fourth, the employment differences generated by differences in tax and transfer programs are necessarily concentrated among young and old workers.
This paper deserves to be studied carefully by economists at Treasury and CBO. The bottom line: For simulating the effects of alternative tax regimes, one should use much larger compensated labor supply elasticities than are conventionally adopted. This conclusion, if accepted, would profoundly affect tax policy analysis, such as dynamic scoring.