More than 65 percent of United States households pay more in payroll taxes than income taxes in a year. Yet, the vast majority of literature on the labor supply changes induced by taxation is derived from changes in income taxes, or an aggregation of payroll and income tax changes. With policymakers proposing payroll tax reform with a view to promote the solvency of Social Security and Medicare, there appears to be an urgent need to inform law makers and the research community on whether changes to payroll taxes alone impact labor supply. In his 2015 working paper, “Do Payroll Taxes in the United States Create Bunching at Kink Points?” David Powell (DP) is the first to explore labor supply responsiveness to U.S. payroll taxes.

DP makes use of a “kink” in labor earnings introduced by the 2009 enactment of Making Work Pay Tax Credit (MWPTC). MWPTC eliminated Social Security tax withholdings on individual labor earning of $6,451 or less, and couple earnings of $12,903 or less. Eliminating withholdings translates into a lower effective tax rate for income groups below this cutoff. However, past the earnings cutoff, marginal tax rates increase suddenly, creating a ”kink” in the marginal tax rate structure at the income cutoff.  Theoretically, when a kink is introduced in earnings, households earning in the vicinity of the kink will tend to locate closer to it to take advantage of the taxation differential. This process of locating in the vicinity of a kink is referred to as bunching.

The MWPTC stayed in effect during half of 2009 and all of the 2010 tax year. It was replaced in 2011 by Payroll Tax Holiday (PTH), which also reduced Social Security taxes up to a larger earnings maximum of $106,800. DP also investigates the new kink at this income.

DB uses the Continuous Work History Sample (CWHS), including all individuals who were ages 25 to 55 years during the time period 2008 to 2011. In order to study the impact of the MWPTC, DB compares the density of the labor earnings distribution in 2009 relative to 2008, and 2010 relative to 2011. Changes in density around kink points in 2009 and 2010 would indicate bunching in response to the tax changes. He argues that 2011 effects should be larger since people had a longer time period—a full tax year—to adjust their labor supply responses. To analyze the effects of the PTH, he compares earnings density around the kink in 2011 to the density in 2009-2010.

Graphical analysis and numerical estimation shows that the MWPTC primarily affected people with self-employment income, with a consistent increase in 2009 and 2010 of people slightly above but within $800 of the kink, implying bunching. At the kink created for couples’ income, DB finds bunching on both sides of the kink and larger bunching effects in 2010 when the MWPTC effect was felt for a full tax year.

The PTH results in bunching below the maximum taxable income, for both people with and without self-employment income. DB asserts that this is a very policy-relevant outcome because it indicates how labor supply will respond to changes in the maximum or the maximum’s elimination.

DB’s estimate of labor supply responsiveness to changes in the tax rate is, however, smaller than estimates found in previous literature. And, as is the nature of analysis at kink points, estimates are very local and it is difficult to assert that similar effects will be found throughout the distribution of labor earnings. The policy changes investigated are also short run and may have had a smaller impact than longer lasting policy changes. However, they constitute the important first step in exploring the effect of payroll tax changes on labor supply, given the paucity of the existing literature.