Adjustment Costs, Firm Responses, and Micro vs. Macro Labor Supply Elasticities: Evidence from Danish Tax Records

75 Pages Posted: 18 Jan 2010 Last revised: 5 Sep 2010

See all articles by Raj Chetty

Raj Chetty

University of California, Berkeley - Department of Economics; National Bureau of Economic Research (NBER)

John N. Friedman

Harvard University - Harvard Kennedy School (HKS); National Bureau of Economic Research (NBER)

Tore Olsen

Harvard University

Luigi Pistaferri

Stanford University; Centre for Economic Policy Research (CEPR)

Date Written: December 2009

Abstract

We show that the effects of taxes on labor supply are shaped by interactions between adjustment costs for workers and hours constraints set by firms. We develop a model in which firms post job offers characterized by an hours requirement and workers pay search costs to find jobs. In this model, micro elasticities are smaller than macro elasticities because they do not account for adjustment costs and firm responses. We present evidence supporting three predictions of the model by analyzing bunching at kinks using the universe of tax records in Denmark. First, larger kinks generate larger taxable income elasticities because they are more likely to overcome search costs. Second, kinks that apply to a larger group of workers generate larger elasticities because they induce changes in hours constraints. Third, firms tailor job offers to match workers' aggregate tax preferences in equilibrium. Calibrating our model to match these empirical findings, we obtain a lower bound on the intensive-margin macro elasticity of 0.34, an order of magnitude larger than the estimates obtained using standard microeconometric methods for wage earners in our data.

Suggested Citation

Chetty, Nadarajan (Raj) and Friedman, John Norton and Olsen, Tore and Pistaferri, Luigi, Adjustment Costs, Firm Responses, and Micro vs. Macro Labor Supply Elasticities: Evidence from Danish Tax Records (December 2009). NBER Working Paper No. w15617. Available at SSRN: https://ssrn.com/abstract=1536388

Nadarajan (Raj) Chetty (Contact Author)

University of California, Berkeley - Department of Economics ( email )

549 Evans Hall #3880
Berkeley, CA 94720-3880
United States
510-643-0708 (Phone)
510-643-0413 (Fax)

National Bureau of Economic Research (NBER)

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Cambridge, MA 02138
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John Norton Friedman

Harvard University - Harvard Kennedy School (HKS) ( email )

79 John F. Kennedy Street
Cambridge, MA 02138
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Tore Olsen

Harvard University ( email )

1875 Cambridge Street
Cambridge, MA 02138
United States

Luigi Pistaferri

Stanford University ( email )

Stanford, CA 94305
United States

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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