Chapter_2_Rogerson_scandinavia - Taxation and Market Work...

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Taxation and Market Work: Is Scandinavia an Outlier? Richard Rogerson Arizona State University January 2, 2006 Abstract This paper argues that in assessing the e ff ects of tax rates on aggregate hours of market work, it is essential to explicitly consider how the government spends tax revenues. Di ff erent choices regarding government spending lead to di ff erent elastic- ities of hours of work with regard to tax rates. I illustrate the empirical importance of this point by addressing the issue of hours worked and tax rates in three sets of economies: the US, Continental Europe and Scandinavia. While tax rates are high- est in Scandinavia, hours worked in Scandinavia are signi fi cantly higher than they are in Continental Europe. I argue that key di ff erences in government spending can potentially account for this pattern. An earlier version of the paper was presented at the 2002 conference in honor of Prescott being award the Nemmers Prize in Economics. I have bene fi tted from the comments of numerous seminar participants, but would like to particularly thank Robert Lucas, Ed Prescott, and Nancy Stokey. I thank the NSF for fi nancial support.
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1. Introduction A large literature seeks to account for the di ff erent evolution of aggregate labor market outcomes between Europe and the US over the last thirty years. Prescott (2002, 2004) and Rogerson (2005) demonstrate that taxes can account for a substantial part of the di ff erences in hours worked that have emerged between the US and the economies of Continental Europe over the last 30 years. 1 While their calculations lend credence to the argument that tax rates are a prime cause of Europe’s distinctive labor market outcomes vis-a-vis the US, one source of skepticism is that the tax explanation does not look so promising when one expands the set of countries beyond this group. In particular, the Scandinavian countries have tax rates at least as high as those found in Continental Europe, yet have much higher hours of work. If one focused exclusively on the economies of Scandinavia and Continental Europe, one would presumably be lead to the conclusion that tax rates themselves are not likely to be particularly important in accounting for di ff erences in hours of work. This paper argues that the evidence on tax rates and hours of work in Continental Europe and Scandinavia should not be interpreted as negative evidence on the mech- anisms emphasized by Prescott (2002, 2004) and Rogerson (2005). The argument is a very simple one: the elasticity of hours worked with regard to tax rates is very much dependent on how tax revenues are spent. I argue that the distinctive features of Scan- dinavian government spending programs can account for the apparently di ff erent e ff ects of taxes in Scandinavia. I illustrate this point in two di ff erent contexts. The fi rst con- text assumes a standard aggregate framework similar to that used by Prescott (2004) in which there is a representative household and a single consumption good. Prescott
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