Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/232683 
Year of Publication: 
2020
Series/Report no.: 
IZA Discussion Papers No. 13931
Publisher: 
Institute of Labor Economics (IZA), Bonn
Abstract: 
This paper studies the speed at which workers' pre-tax earnings respond to tax changes along the intensive margin. We do so in the context of Germany, where a large discontinuity – or notch – in the tax schedule induces sharp bunching in the earnings distribution. We analyze earnings responses to two policy reforms that shift this notch outward. In a frictionless world, the workers that made up the excess mass at the old notch should all increase their earnings. While some of these workers indeed adjust their earnings rapidly, over 38% do not, and instead take several years to adjust. We propose that heterogeneity in firm labor demand plays a key role in generating the observed differences in the speed of workers' earnings responses and predict that adjustment will be quickest at growing firms. We test and find support for these demand-side effects in our linked employer-employee data.
Subjects: 
labor supply responses to taxation
earnings adjustment frictions
labor demand
JEL: 
H24
H31
J22
J23
Document Type: 
Working Paper

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