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  5. Labor Supply Responses and Adjustment Frictions: A Tax-Free Year in Iceland

American Economic Journal:
Economic Policy

ISSN 1945-7731 (Print) | ISSN 1945-774X (Online)

Labor Supply Responses and Adjustment Frictions: A Tax-Free Year in Iceland

  • Jósef Sigurdsson
American Economic Journal: Economic Policy (Forthcoming)

Abstract

Labor income earned in Iceland in 1987 went untaxed. I use this episode to study labor supply responses to temporary wage changes. Using a population-wide dataset of earnings and working time and two identification strategies, I estimate intensive and extensive margin Frisch elasticities of 0.4 and 0.09, respectively. Workers with the ability to adjust drive these average responses: extensive margin by young and close-to-retirement cohorts and intensive margin responses by workers in temporally flexible jobs, though secondary jobs contribute to one-tenth of the response. The results suggest that adjustment frictions may similarly explain differences in elasticities within and across countries.

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