Life-Cycle Labor Supply with Human Capital: Econometric and Behavioral Implications

I examine the econometric and behavioral implications of including human capital in the life-cycle labor supply model. With human capital, the wage no longer equals the opportunity cost of time – which is, instead, the wage plus returns to work experience. This has a number of important implications, of which I highlight four: First, labor supply elasticities become functions of both preference and wage process parameters. Thus, one cannot estimate elasticities without also specifying and estimating the wage process. Second, once human capital is accounted for, the data appear consistent with much larger labor supply elasticities than most prior work suggests. Third, contrary to much conventional wisdom, permanent tax changes can have larger effects on current labor supply than temporary tax changes. Fourth, human capital amplifies the labor supply response to permanent tax changes in the long-run, because a permanent tax reduces the rate of human capital accumulation, slowing the growth of wages.