The Effects of Progressive Taxation on Labor Supply when Hours and Wages are Jointly Determined
This paper extends a standard intertemporal labor supply model to account for progressive
taxation as well as the joint determination of hourly wages and hours worked.
We show, qualitatively and quantitatively, that these two factors have implications for
estimating the intertemporal elasticity of substitution. Furthermore, we show how to use
the intertemporal elasticity of substitution to interpret the labor supply response to a tax
change. Failure to account for wage-hours ties within a progressive tax system leads to
an hours response to a change in marginal tax rates that may be understated by as much
as 10 percent for men and 17 percent for women.
