Are income and consumption taxes ever really equivalent? Evidence from a real-effort experiment with real goods

Abstract

The public finance literature demonstrates the equivalence between consumption and labor income (wage) taxes. We construct an environment in which individuals make real labor-leisure choices and spend their earned income on real goods. We use this experimental framework to test whether a labor income tax and an equivalent consumption tax lead to an identical labor-leisure allocation. Despite controlling for subjects' work ability and inherent labor-leisure preferences and not allowing for saving, subjects reduce their labor supply significantly more in response to an income tax than they do in response to an equivalent consumption tax. We discuss the economic implications of a policy shift from an income to a consumption tax.

Tax aversion in labor supply

“…First, previous research demonstrates that taxes have a larger effect when more salient (e.g., Chetty et al, 2009;Blumkin et al, 2012), typical of a focusing illusion where making any attribute particularly salient leads that attitude to exert an outsized influence on decision-making (Kahneman et al, 2006). In our experiment, taxes are made explicit at the very moment that workers choose their labor supply decision.…”

“…Field results on tax salience demonstrate that individuals respond less to a tax when the tax is less explicit Finkelstein, 2009;Cabral and Hoxby, 2012;Jones, 2012). Recent laboratory research has supported the claim that individuals respond more to taxes that are more salient (e.g., Sausgruber and Tyran, 2005;Blumkin et al, 2012), and increases in income taxes are often less salient than equivalent decreases in wages. found that laboratory workers who were paid the same net wage worked harder and longer when they faced higher gross wages and higher tax rates: a result they called "net wage illusion" since workers behaved as though their net wage was higher because their gross wage was higher.…”

“…Much of this literature examines the effect of taxes, which may or may not be salient and may or may not be complex, on workers who must calculate their net wage from their gross wage and the tax schedule (e.g., Swenson, 1988;Blumkin et al, 2012;Hayashi et al, 2013;Weber and Schram, 2013;Doerrenberg and Duncan, 2014;Abeler and Jager, 2015). 4 Other research examines labor supply responses to net-of-tax wages without explicit mention of taxes (Sillamaa, 1998(Sillamaa, , 1999a.…”

Nominal or Real? The Impact of Regional Price Levels on Satisfaction with Life

“…An overreaction to prices is plausible if prices are more salient than nominal income. The importance of salience effects is documented in Chetty et al (2009), Blumkin et al (2012), and Finkelstein (2009 who provide evidence that consumers fail to sufficiently take into account less salient aspects in decision making. 3 Income is usually paid monthly and changes only infrequently.…”

Experimental evidence on the relationship between tax evasion opportunities and labor supply

“…Blumkin et al 2012 for a recent example which handles payment in a similar manner). Additionally, this payment method, along with the fact that subjects were not informed about the prevailing tax rate until the start of a round, avoids adding an intertemporal component to our experiment.…”