Standard Deviation Abstract
The purpose of this study is to show how taxes affect hours worked in a model where hours and wages are jointly determined. Standard labor supply elasticity measure the relationship between labor supply and the wage. Tax analysts use these estimated labor supply elasticity to predict the labor supply response to a tax change. However, tax analysts usually fail to account for the effect of hours worked on the wage. This failure creates a problem because a tax increase not only lowers the after-tax wage because of a change in the marginal tax rate but also indirectly lowers the pre-tax wage through the tax change’s effect on hours worked. Therefore, failure to account for this latter effect leads to an underestimate of the effect of tax changes on the post-tax wage and consequently to an underestimate of the effect of tax changes on labor supply.
Hours worked in a model where hours