Co-Worker Spillovers from a Top Income Tax Cut
Introduction
Labanca and Pozzoli (2018) studies the relationship between worker performance and the level to which workers must coordinate their working hours with one another. Using matched employer-employee data from Denmark, the paper argues that more productive firms exhibit higher degrees of hours coordination.
The paper exploits a reform that significantly decreased top income tax rates in 2010 to estimate labor supply elasticities that account for hours coordination. The paper finds that workers impacted by the tax change at high coordination firms did not reduce their labor supply in response to the tax change, while those in low coordination firms did. The paper also investigates the labor supply response of workers who were not directly impacted by the tax change and estimates that the spillover effects work in the same direction: if workers directly affected by the tax change responded by decreasing their labor supply, workers at the same firm who were not directly affected also respond by decreasing their labor supply. This spillover effect is stronger in high coordination firms.
Paradisi (2021) uses the results in Labanca and Pozzoli (2018) to compute the MVPF of a cut in top income tax rates.
MVPF = 0.2
Net Cost
Paradisi (2021) classifies workers into two categories: top earners (subject to the tax reform) and low earners (only subject to spillover effects). The paper reports two main components of the net cost of the tax change: the direct revenue lost due to the lowering of the tax rate and the fiscal externality due to changes in labor supply of both top and low earners.
To compute the direct revenue losses, the paper multiplies the change in the net-of-tax rate by the total yearly pre-tax top labor earnings (earnings above the top income-tax threshold and that threfore are subject to the top income-tax rate): 0.0037 x €1,767,184 = €6,665.
To compute the fiscal externalities, Paradisi (2021) first notes that Labanca and Pozzoli (2018) found no effect of the reform on wages. Therefore, the only fiscal externality happens through changes in labor supply. To estimate the change in earnings caused by the reform, the paper multiplies the percent change in hours of labor supplied by top workers due to a one percent increase in the net-of-tax rate (elasticity of 0.00047) by the total yearly earnings in the group (€8,493,800). The paper then multiplies that by the pre-reform tax rate at the top (62.3%) to arrive at the change in tax revenue due to behavioral responses: 0.00047 x 0.623 x €8,493,800 = €2,486.
Next, the paper uses the result that for a 1 percent increase in hours worked by top earners, low earners work hours reduce by 0.8 percent through the hours coordination channel. A marginal tax change at the top therefore causes a change in labor earnings among low earners given by the product of the elasticity of labor supply at the top (0.00047) times the coordination elasticity (0.8 x 0.00047 = 0.000376). The total change in earnings due to the policy change is given by multiplying this figure by the total yearly earnings among bottom earners €3,784,200, equalling -€1,561. This causes a change in tax revenue equal to low earner’s marginal tax rate (40%) multiplied by their change in labor earnings: 0.4 x €1,561 = -€617.45.
The total net cost is the sum of the mechanical cost and fiscal externalities: €6,665 + €2,486 – €617.45 = €8,535.
Willingness to Pay
Paradisi (2021) estimates two components of the willingness to pay for a marginal reduction in the top income tax rate.
First, the tax cut directly increases the post-tax income of top earners. The paper multiplies the change in the net-of-tax rate by the total pre-tax top labor earnings for a total of 0.0037 x €1,767,184 = €6,665.
Second, the tax cut caused both top and bottom earners to reduce their labor supply. The paper assumes that, due to the necessity to coordinate hours, hours of labor are not freely chosen by workers but determined by firms. Therefore, changes in hours of work caused by the tax change directly affect workers’ utility. The paper shows that within each group of workers, this utility impact is given by the product of the change in hours worked and the marginal utility effect of a change in number of hours worked caused by hours coordination. This marginal utility effect is given by the sum of the marginal disutility of hours worked and the value of every hour worked (equal to average net-of-tax wages). Paradisi (2021) assumes that the marginal disutility of work equals the net-of-tax wage, which is observed in the sample.
The willingness to pay of top earners is given by the percentage change in hours (elasticity of 0.00047) times total hours of work (46,250) times the marginal utility impact of changing labor supply (-€138.5), for a total of 0.00047 x 46,250 x -€138.5 = €-3,011.
The willingness to pay of bottom earners is given by the percentage change in hours (elasticity of 0.00047) by total hours of work (29,120) multiplied by the marginal utility impact of changing labor supply (-€157.12), for a total of 0.00047 x 29,120 x -€157.12 = €-1,888.
Then the overall willingness to pay for the policy change is €6,665 – €3,012 – €1,888 = €1,766.
MVPF Summary
The MVPF of cutting the top income tax rate is 1,766/8,535=0.21.
Labanca and Pozzoli (2018) has since been published as Labanca and Pozzoli (2022). The estimates used from Labanca and Pozzoli (2018) for the MVPF estimate remained the same in the 2022 published version
References
Labanca, Claudio and Dario Pozzoli (2018). “Constraints on Hours within the Firm.” IZA Working Paper. https://www.iza.org/publications/dp/12062/coordination-of-hours-within-the-firm
Labanca, Claudio and Dario Pozzoli (2022). “Constraints on Hours within the Firm.” Journal of Labor Economics: 40(2): 473-503. DOI: https://doi.org/10.1086/714827
Paradisi, Matteo (2021). Firms and Policy Incidence. Working Paper.
https://uploads-ssl.webflow.com/5d8e3657fd776a7142924af1/60b107ce7b635e55ff194322_paradisi_2021_firms_policy_incidence.pdf
Policy Features
- Category
- Taxes
- Sub-Category
- Top Taxes
- Beneficiary Type(s)
- Top Income Earners
- Country of Implementation
- Denmark
- Year of Implementation
- 2010
- Empirical Method
- Difference in Differences
- Research Type
- Primary
- Peer Reviewed
- No