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Iceland's Natural Experiment in Supply-Side Economics

Author

Listed:
  • Zoega, Gylfi
  • Bianchi, Marco
  • Gudmundsson, Björn R

Abstract

The move to a pay-as-you-earn income tax system in Iceland in 1987-1988 made income earned in 1987 tax-free. Using a sample of 9,274 individuals for the years 1986, 1987 and 1988, we calculate the labour-supply response of this change and find that total labour supply rose by 6.7% in 1987 over the average of 1986 and 1988 when we correct for entry in 1988. This consists of an 8.6% increase in weeks supplied by those already in the labour market in 1986 and a 1.9% decline due to entry/exit. The elasticity of weeks worked to the rise in after-tax wages was 0.41 for men and 0.11 for women. While the participation rate of women increased somewhat in our sample, participation by men fell.

Suggested Citation

  • Zoega, Gylfi & Bianchi, Marco & Gudmundsson, Björn R, 2000. "Iceland's Natural Experiment in Supply-Side Economics," CEPR Discussion Papers 2367, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:2367
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    1. Fullerton, Don, 1982. "On the possibility of an inverse relationship between tax rates and government revenues," Journal of Public Economics, Elsevier, vol. 19(1), pages 3-22, October.
    2. Feldstein, Martin, 1986. "Supply Side Economics: Old Truths and New Claims," American Economic Review, American Economic Association, vol. 76(2), pages 26-30, May.
    3. Nada Eissa & Jeffrey B. Liebman, 1996. "Labor Supply Response to the Earned Income Tax Credit," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 111(2), pages 605-637.
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    1. Erich Battistin & Agar Brugiavini & Enrico Rettore & Guglielmo Weber, 2009. "The Retirement Consumption Puzzle: Evidence from a Regression Discontinuity Approach," American Economic Review, American Economic Association, vol. 99(5), pages 2209-2226, December.
    2. Ali Elminejad & Tomas Havranek & Roman Horvath & Zuzana Irsova, 2023. "Intertemporal Substitution in Labor Supply: A Meta-Analysis," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 51, pages 1095-1113, December.
    3. Roman Horvath & Ali Elminejad & Tomas Havranek, 2020. "Publication and Identification Biases in Measuring the Intertemporal Substitution of Labor Supply," Working Papers IES 2020/32, Charles University Prague, Faculty of Social Sciences, Institute of Economic Studies, revised Sep 2020.
    4. Jouko Verho & Kari Hämäläinen & Ohto Kanninen, 2022. "Removing Welfare Traps: Employment Responses in the Finnish Basic Income Experiment," American Economic Journal: Economic Policy, American Economic Association, vol. 14(1), pages 501-522, February.
    5. Michaël Sicsic, 2022. "Does labour income react more to income tax or means‐tested benefits reforms?," Fiscal Studies, John Wiley & Sons, vol. 43(3), pages 291-319, September.
    6. Hian Teck Hoon, 2009. "Payroll Taxes, Wealth and Employment in Neoclassical Theory: Neutrality or Non-neutrality?," Working Papers 08-2009, Singapore Management University, School of Economics.
    7. Gilles Le Garrec & Vincent Touzé, 2018. "Prélèvement à la source de l'impôt sur le revenu et année de transition : quel impact pour les finances publiques et l'équité générationelle ?," SciencePo Working papers Main hal-03458262, HAL.
    8. Gilles Le Garrec & Vincent Touzé, 2016. "Prélèvement à la source de l'impot sur le revenu et année de transition : quel impact pour les finances publiques et l'équité fiscale ?," Documents de Travail de l'OFCE 2016-28, Observatoire Francais des Conjonctures Economiques (OFCE).
    9. Isabel Z. Martínez & Emmanuel Saez & Michael Siegenthaler, 2021. "Intertemporal Labor Supply Substitution? Evidence from the Swiss Income Tax Holidays," American Economic Review, American Economic Association, vol. 111(2), pages 506-546, February.
    10. David Staines, 2023. "Stochastic Equilibrium the Lucas Critique and Keynesian Economics," Papers 2312.16214, arXiv.org, revised Jun 2024.
    11. Sigurdsson, Jósef, 2023. "Transitory Earnings Opportunities and Educational Scarring of Men," IZA Discussion Papers 16050, Institute of Labor Economics (IZA).
    12. Jósef Sigurdsson, 2023. "Transitory Earnings Opportunities and Educational Scarring of Men," CESifo Working Paper Series 10361, CESifo.
    13. Petri Böckerman & Markus Jäntti, 2005. "Is Variation in Hours of Work Driven by Supply or Demand? Evidence from Finnish Manufacturing Industries," Labor and Demography 0505012, University Library of Munich, Germany.
    14. Raj Chetty & Adam Guren & Day Manoli & Andrea Weber, 2013. "Does Indivisible Labor Explain the Difference between Micro and Macro Elasticities? A Meta-Analysis of Extensive Margin Elasticities," NBER Macroeconomics Annual, University of Chicago Press, vol. 27(1), pages 1-56.
    15. repec:spo:wpmain:info:hdl:2441/5f6r8mtjsm80ras2hkv5b13987 is not listed on IDEAS
    16. Ólafsdóttir, Thorhildur & Hrafnkelsson, Birgir & Thorgeirsson, Gudmundur & Ásgeirsdóttir, Tinna Laufey, 2016. "The tax-free year in Iceland: A natural experiment to explore the impact of a short-term increase in labor supply on the risk of heart attacks," Journal of Health Economics, Elsevier, vol. 49(C), pages 14-27.
    17. repec:hal:spmain:info:hdl:2441/5f6r8mtjsm80ras2hkv5b13987 is not listed on IDEAS
    18. Andrés Erosa & Luisa Fuster & Gueorgui Kambourov, 2016. "Towards a Micro-Founded Theory of Aggregate Labour Supply," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 83(3), pages 1001-1039.
    19. Chad Brown & Jeronimo Carballo & Alessandro Peri, 2022. "Bankruptcy Shocks and Legal Labor Markets: Evidence from the Court Competition Era," Papers 2202.00044, arXiv.org.
    20. Charles Whalen & Felix Reichling, 2017. "Estimates of the Frisch Elasticity of Labor Supply: A Review," Eastern Economic Journal, Palgrave Macmillan;Eastern Economic Association, vol. 43(1), pages 37-42, January.
    21. Raj Chetty, 2012. "Bounds on Elasticities With Optimization Frictions: A Synthesis of Micro and Macro Evidence on Labor Supply," Econometrica, Econometric Society, vol. 80(3), pages 969-1018, May.
    22. Gottlieb, Charles & Onken, Joern & Valladares-Esteban, Arnau, 2021. "On the measurement of the elasticity of labour," European Economic Review, Elsevier, vol. 139(C).
    23. Raj Chetty & Adam Guren & Day Manoli & Andrea Weber, 2011. "Are Micro and Macro Labor Supply Elasticities Consistent? A Review of Evidence on the Intensive and Extensive Margins," American Economic Review, American Economic Association, vol. 101(3), pages 471-475, May.
    24. Lundberg, Jacob & Norell, John, 2018. "Taxes, benefits and labour force participation: A survey of the quasi-experimental literature," Ratio Working Papers 313, The Ratio Institute.

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    More about this item

    Keywords

    Labour supply; Supply-side economics;

    JEL classification:

    • E65 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Studies of Particular Policy Episodes
    • J22 - Labor and Demographic Economics - - Demand and Supply of Labor - - - Time Allocation and Labor Supply

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