Taxes in a Labor Supply Model with Joint Wage-Hours Determination

PAYROLL AND PROGRESSIVE INCOME taxes play an enormous role in the American fiscal system. It is therefore of some importance to know the extent to which they influence work incentives. The purpose of this study is to present some econometric evidence on the effects of taxes on married women, a group of growing importance in the American labor force.2 A testable model of labor supply is developed which permits statistical estimation of a coefficient of tax perception. Unlike previous models of labor supply, it allows for the possibility that the wage may depend on the number of hours worked. Contrary to much of the literature, the results of this paper strongly suggest that marginal tax rates do have an important impact on labor force behavior. This section reviews briefly the past thought on this problem. Section 2 develops a model to explain work decisions when an individual faces a whole set of wagehour combinations, rather than a given wage independent of the number of hours he works. In Section 3 this model is modified to permit an explicit test of whether or not taxes affect individuals' labor supply decisions. Estimation problems are discussed at length, and the empirical results are presented. A concluding section contains a summary and suggestions for future research.