Adjustment Costs, Firm Responses, and Micro vs. Macro Labor Supply Elasticities: Evidence from Danish Tax Records
We show that the effects of taxes on labor supply are shaped by interactions between adjustment costs for workers and hours constraints set by firms. We develop a model in which firms post job offers characterized by an hours requirement and workers pay search costs to find jobs. In this model, micro elasticities are smaller than macro elasticities because they do not account for adjustment costs and firm responses. We present evidence supporting three predictions of the model by analyzing bunching at kinks using the universe of tax records in Denmark. First, larger kinks generate larger taxable income elasticities because they are more likely to overcome search costs. Second, kinks that apply to a larger group of workers generate larger elasticities because they induce changes in hours constraints. Third, firms tailor job offers to match workers' aggregate tax preferences in equilibrium. Calibrating our model to match these empirical findings, we obtain a lower bound on the intensive-margin macro elasticity of 0.34, an order of magnitude larger than the estimates obtained using standard microeconometric methods for wage earners in our data.
We would like to thank David Card, Stephen Coate, Edward Glaeser, James Hines, Han Hong, Lawrence Katz, Henrik Kleven, Claus Kreiner, Patrick Kline, Erzo Luttmer, Robert Moffitt, John Pencavel, Emmanuel Saez, Esben Schultz, and numerous seminar participants for helpful suggestions and valuable discussion. We are extremely grateful to Mette Ejrnæs and Bertel Schjerning at the Centre for Applied Microeconometrics at the University of Copenhagen, Frederik Hansen at the Ministry of Finance, Peter Elmer Lauritsen at Statistics Denmark, as well as Anders Frederiksen, Paul Bingley, and Niels Chr. Westergård-Nielsen at Aarhus Business School for help with the data and institutional background. Gregory Bruich, Jane Choi, and Keli Liu provided outstanding research assistance. We are also extremely grateful to Chris Walker and the Harvard Research Computing group for technical assistance. Support for this research was provided by the Robert Wood Johnson Foundation and NSF Grant SES-0645396. The views expressed herein are those of the author(s) and do not necessarily reflect the views of the National Bureau of Economic Research.
Raj Chetty & John N. Friedman & Tore Olsen & Luigi Pistaferri, 2011. "Adjustment Costs, Firm Responses, and Micro vs. Macro Labor Supply Elasticities: Evidence from Danish Tax Records," The Quarterly Journal of Economics, Oxford University Press, vol. 126(2), pages 749-804. citation courtesy of