Taxation and Labor Supply of Married Women: The Tax Reform Act of 1986 as a Natural Experiment

Abstract

This paper uses the Tax Reform Act of 1986 as a natural experiment to identify the labor supply responsiveness of married women to changes in the tax rate. The Tax Reform Act of 1986 reduced the top marginal tax rate by 44 percent (from 50 percent to 28 percent), but changed less the marginal tax rate for those further down the income distribution. I analyze the response of married women at or above the 99th percentile of the income distribution, using as a control group women from the 75th percentile of the income distribution. I therefore identify the tax effect as the difference between the change in labor supply of women with large tax rate reductions and the change in labor supply of women with small tax rate reductions. I find evidence that the labor supply of high-income, married women increased due to the Tax Reform Act of 1986. The increase in total labor supply of married women at the top of the income distribution (relative to married women at the 75th percentile of the income distribution) implies an elasticity with respect to the after- tax wage of approximately 0.8. At least half of this elasticity is due to labor force participation. Use of a second control group supports the participation response but is inconclusive on the hours of work response.