Finance and Economics Discussion Series (FEDS)
February 2010
Income Taxes, Compensating Differentials, and Occupational Choice: How Taxes Distort the Wage-Amenity Decision
Hui Shan and David Powell
Abstract:
The link between taxes and occupational choices is central for understanding the welfare impacts of income taxes. Just as taxes distort the labor-leisure decision, they also distort the wage-amenity decision. Yet, there are no estimates of the full response on this margin. When tax rates increase, workers favor jobs with lower wages and more non-taxable amenities. We introduce a two-step methodology which uses compensating differentials to characterize the tax elasticity of occupational choice. We estimate a significant compensated elasticity of 0.05, implying that a 10% increase in the net-of-tax rate causes workers to change to a 0.5% higher wage job.
Full paper (Screen Reader Version)Keywords: Income taxes, occupational choice, compensating differentials
PDF: Full Paper
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