Social norms and macro labor supply estimates
Krugman has suggested that Ryan Avent and I look at the literature on labor supply elasticities. Or perhaps, as Ambrosini suggests, just the half of that literature with which he agrees:
Today he says that Sumner and Avant should read the literature on macro vs micro labor supply elasticities. Well, ok, he says they should only read half of that literature. Over the last decade, Prescott has been doing a lot of work showing that differences in taxes explain differences in employment and hours worked between Europe and the US. I think his Nobel speech was about this.
The micro people threw fits though because their estimates of the response of labor supply to tax changes is much less extreme than Prescott’s finding suggest. They basically find labor supply curves are vertical. This would mean that taxes simply can’t have an effect on labor supply.
For a while, these guys had me convinced because, in general, micro/labor types do a much better job of identification and I trust their estimates more than I trust macro estimates. More recently, however, macro people1 have been making the case that the “labor supply elasticity” estimated by the micro people is different from the “labor supply elasticity” the macro people estimate. The difference isn’t due to statistical methodology, we were just calling two different things the same thing.
Of course, its the macro elasticity that matters for tax policy, though. Prescott’s work (and not the paper that PK links to) is the place to go for understanding differences between Europe and the US. He says that difference is due to differences in tax and transfer policies.
I haven’t studied the recent literature in this field, although of course I was aware of the Prescott study. But if Ambrosini is right I feel much less ignorant than I feared. Back in the 1970s at Chicago we were taught that you needed to use income compensated supply and demand curves when examining tax policy. I just assumed that everyone knew that when government collected taxes, the money was injected back into the economy through various means. I guess this insight only recently reached certain segments of the profession. Now of course the progressives that favor high taxes can always argue that the government expenditures go to activities that are so worthless that society is impoverished. In that case people keep working hard for the same reason Bangladeshis work hard. But I’m going to assume they don’t want to make that argument.
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