Labor Market Effects of Tax Changes in Times of High and Low Unemployment: Working Paper 2020-05
The results of this analysis indicate that tax changes have significant effects on labor market outcomes, but those effects vary depending on the state of the economy at the time a tax change is implemented.
This paper examines how the effects of legislated tax changes on labor market outcomes vary with the amount of slack in the economy, as measured by the rate of unemployment. I find that effects on hours worked, employment, and the unemployment rate become smaller in times of higher unemployment. I then develop a theoretical model in which changes in taxes on labor income directly affect the demand for labor by changing the costs that firms incur for employing workers. In the model, tax changes have smaller effects in times of higher unemployment because overall employee costs become less sensitive to after-tax wages when there is slack in the labor market. A calibrated version of the model is fairly successful in reproducing the estimated differences in the effects of tax changes across periods of high and low unemployment.
The information in this paper is preliminary and is being circulated to stimulate discussion and critical comment as developmental work for analysis for the Congress. The views expressed here should not be interpreted as CBO’s.