The Non-Equivalence of Labor Market Taxes: A Real-Effort Experiment

In a competitive market with taxed transactions, it does not matter under full rationality which side of the market legally transfers the taxes. In the labor market, a tax levied on employers and a corresponding income tax levied on employees are equivalent. With boundedly rational agents, this equivalence is no longer obvious. If people react differently to the two taxes this has direct impact on policy making, political economics, and optimal taxation theory. This paper examines how people react to these duties in a real effort laboratory experiment. We study the differential effects of the two types of taxes on preferences concerning the size of the public sector, subjective well-being, labor supply, and on-the-job performance. To elicit public-sector-size preferences in the laboratory we introduce a novel, incentive compatible approach. Our findings suggest that employer-side taxes induce preferences for a larger public sector. Our findings also sugges t that subjective well-being is higher while both labor supply and on-the-job performance are lower when the taxes are levied on employers. Furthermore, there are gender effects, e.g., women's subjective well-being appears to be more sensitive to framing than men's, while men's labor supply is more sensitive to framing than women's.