Finance and Economics Discussion Series

The Effect of Taxation on Lifecycle Labor Supply: Results from a Quasi-Experiment

Jane K. Dokko
2008-24

Abstract: In predicting the magnitude of the labor supply response to taxation, the standard lifecycle labor supply model distinguishes between unanticipated and anticipated changes in the after-tax return to working. Exploiting age-eligibility rules for claiming a dependent on a tax return facilitates a comparison of the labor supply outcomes of households who are equivalent but for the tax schedule they face. I find that the quasi-random assignment to a tax schedule without an age-eligible dependent corresponds to a decrease in mothers' labor supply by about 40 hours per year and to no discernible effect for fathers. While having an age-ineligible dependent results in a 0.5 percentage point, or 0.3%, average decrease in a household's net-of-tax rate, further analysis of average tax rates suggests that the variation in marginal tax rates does not fully explain mothers' labor supply responses. This finding militates against interpreting this large response as an intertemporal elasticity and subsequently presents a puzzle for the lifecycle labor supply model.

Keywords: Labor supply, taxation, quasi-experimental methods