Estimating Intensive and Extensive Tax Responsiveness: Do Older Workers Respond to Income Taxes?

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. The authors model labor force participation decisions and labor earnings as functions of taxes. They estimate the intensive and extensive margins simultaneously, introducing a new method to estimate labor supply decisions more broadly. Their method accounts for selection into labor force participation with a plausibly exogenous shock to employment. They use the results of their intensive labor supply estimation to predict the after-tax labor earnings of every person in their sample, including those that do not work in the next period. This method allows them to generate consistent estimates of the impact of taxes on employment and retirement. They find insignificant compensated elasticities on the intensive margin. On the extensive margin, they find significant effects on labor force participation and retirement decisions. Their estimates suggest that an age-targeted tax reform that eliminates payroll taxes for older workers would decrease the percentage of both men and women dropping out of the labor force by almost one percentage point, a 3% decrease. They find that most of this decrease in labor force participation is associated with an increase in retirement.

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