Taxation, Human Capital, and Uncertainty

The growth of tax rates on earned income has focused attention upon the impact of such taxes on work effort. The effect of taxes on hours of work has been the subject of both careful theoretical and econometric study. The basic lesson of the theoretical literature is that the impact of taxation on hours of work is logically indeterminate because of the familiar conflict between income and substitution effects. Therefore, an enormous amount of econometric research has been done on this subject. Although there is a disconcertingly high variance in estimates of labour supply elasticities, it would probably be fair to say that the consensus is that the response in hours of work to changes in the net wage is very small for prime age male earners. This finding has been interpreted by some as evidence that taxes have little influence on work effort.