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Presented By: Department of Economics

Micro vs Macro Labor Supply Elasticities: The Role of Dynamic Compensation

Henrik Kleven, Princeton University

Micro vs Macro Labor Supply Elasticities: The Role of Dynamic Compensation Micro vs Macro Labor Supply Elasticities: The Role of Dynamic Compensation
Micro vs Macro Labor Supply Elasticities: The Role of Dynamic Compensation
A central and still unresolved tension in economics is the discrepancy between micro and macro elasticities of earnings with respect to marginal tax rates. We revisit this puzzle, focusing on the role of dynamic returns to effort among top earners. We start by developing a simple theoretical model of earnings responses to taxes in the presence of dynamic returns. In this model, the returns to effort are delayed and centered around discrete job switches such as promotions within firms or movements between firms. Short-run micro elasticities are attenuated relative to the true long-run macro elasticity. We proceed by providing two main empirical analyses using rich administrative data from Denmark. The first part presents descriptive evidence on earnings and hours-worked patterns over the lifecycle that confirm the predictions of the theoretical model. The second part presents quasi-experimental evidence on earnings responses to taxes using discrete job switches. The empirical strategy is informed by the theoretical model, according to which job switches can be used to (partially) identify the macro elasticity of labor supply. The evidence shows that, at the top of the distribution, macro elasticities are much larger than micro elasticities due to dynamic compensation effects. The normative implications of these findings are analyzed.
Micro vs Macro Labor Supply Elasticities: The Role of Dynamic Compensation Micro vs Macro Labor Supply Elasticities: The Role of Dynamic Compensation
Micro vs Macro Labor Supply Elasticities: The Role of Dynamic Compensation

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