Research in Progress
“The Tax Elasticity of Labor Income Throughout the Income Distribution: The Introduction of a Fixed Effects Quantile Estimator”
This paper estimates the elasticity of labor income with respect to wage and income taxes in the United States. Because labor income can be taxed independently of other types of income, it is important to isolate its response to changes in tax rates. Furthermore, nonlinear tax schedules (most relevantly, the FICA cap) allow marginal tax rates to differ throughout the income distribution and it is, therefore, crucial to understand how the elasticity changes by income. In this paper, I introduce the Fixed Effects Quantile Estimator (FEQE) to estimate the tax elasticity of labor income throughout the income distribution. This estimator allows for an arbitrary correlation between the fixed effects and the instruments, does not suffer from an incidental parameters problem, and relies on minimal assumptions. The estimator in this paper defines the quantiles based on both the fixed effect and the observation-specific residual, which is critical in this context. To deal with the potential endogeneity of individual tax rates, I use an instrumental variable strategy which relies on the fact that two workers with the same labor income may face very different changes in marginal tax rates if they have different initial secondary or capital earnings. This instrument should isolate the effect of labor supply choices from general equilibrium effects resulting from tax changes and wage trends.
“Good Pay or Pays Goods: The Impact of Income Taxes on Occupational Choice” (with Hui Shan)
The link between taxes and occupational choices is central for understanding the welfare impacts of income and wage taxes. Just as taxes distort the labor-leisure decision, they also distort the wage-amenity decision. When income tax rates increase, workers should favor jobs with lower wages and higher non-wage amenities. However, very few papers have isolated this effect. We introduce a two-step estimation strategy to isolate the elasticity of occupation choice with respect to tax rates, testing whether workers select higher (lower) wage jobs when tax rates decrease (increase). To isolate occupational choices from the general equilibrium effects that tax schedule changes might have on wages, we use an instrumental variable strategy which recognizes that workers within an occupation may experience different tax changes due to differences in initial secondary and capital earnings. We estimate a statistically significant overall compensated elasticity of 0.05, implying that a 10% increase in the net-of-tax rate causes workers to change to a job with a 0.5% higher wage.