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Tax Elasticity of Labor Earnings for Older Individuals

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Abstract

This paper studies the impact of income and payroll taxes on intensive and extensive labor supply decisions for workers ages 55-74 using the Health and Retirement Study. The literature provides little guidance about the responsiveness of this population to tax incentives, though the tax code is potentially an important mechanism that can alter retirement incentives. We model labor force participation decisions and labor earnings as functions of taxes, and we use the intensive margin to inform estimation of the extensive margin equation. Our method accounts for selection into labor force participation with a plausibly exogenous shock to employment. We use the results of our intensive labor supply estimation to predict the after-tax labor earnings of every person in our sample, including those that do not work. This method allows us to generate consistent estimates of the impact of taxes on employment and retirement. We find large compensated elasticities on the intensive margin. These results are imprecise, but they are statistically significant for women. On the extensive margin, we find significant effects on labor force participation and, for men, retirement decisions. Our estimates suggest that an age-targeted tax reform that eliminates payroll taxes for older workers would decrease the percentage of workers dropping out of the labor force by 1 percentage point, a 4% decrease.

Key Findings

  • Studying workers ages 55-74, we find that both men and women are less likely to work if their labor income is subject to higher taxes.  Men are more likely to report themselves as retired in response to tax increases.
  • We find suggestive evidence that increases in the marginal tax rate are associated with reductions in labor earnings.
  • Elimination of the employee portion of payroll taxes for this population would decrease the percentage of workers, both men and women, dropping out of the labor force by 1 percentage point, a 4 percent decrease from the baseline rate.

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Project

Paper ID

WP 2012-272

Publication Type

Working Paper

Publication Year

2012