Labour Supply and Incentives to Work in Europe
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Labour Supply and Incentives to Work in Europe

Edited by Ramón Gómez-Salvador, Ana Lamo, Barbara Petrongolo, Melanie Ward and Etienne Wasmer

Labour Supply and Incentives to Work in Europe highlights recent developments in the labour supply in Europe and gives a detailed assessment of their link with economic policies and labour market institutions. Despite major changes in European labour supply during the past few decades, the existing literature still lacks a comprehensive study of the relationship between labour supply and labour market institutions from a macro perspective.
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Chapter 2: Tax-effects on Work Activity, Industry Mix and Shadow Economy Size: Evidence from Rich Country Comparisons

Steven J. Davis and Magnus Henrekson


2. Tax effects on work activity, industry mix and shadow economy size: evidence from rich country comparisons1 Steven J. Davis and Magnus Henrekson INTRODUCTION Taxes on labour income and consumption expenditures encourage households to substitute away from the legal market sector in favour of untaxed activities – leisure, household production and the shadow economy. We investigate these substitution responses by relating measures of employment, market work hours, shadow economy size and the industry mix of market production activity to tax rate differences among rich countries. Our objective is to assess the long-run total response of these outcomes to persistent differences in tax rates on labour income, payrolls and consumption – collectively, personal taxes. By ‘total response’ we mean the direct effects that work through labour supply and demand plus indirect effects that involve government spending responses to available tax revenues. As in Brennan and Buchanan (1980), Krusell et al. (1996), Persson and Tabellini (2002) and Becker and Mulligan (2003) we recognize that taxing capacity affects government expenditures. In turn, many expenditure programmes affect labour supply incentives. Leading examples include government programmes for unemployment and disability insurance. Our sample of rich countries offers a modest number of data points. Despite this limitation, the broad-brush comparisons that we undertake are useful for several reasons. First, a focus on national outcomes provides information about the combined effect of taxes working through labour supply and labour demand channels. In this regard we stress that tax effects...

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