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Journal Article
Rise of employees and growth in tax capacity
2015
Overview
This paper studies how the transition from self-employment to employee employment share over the development path can explain growth in personal income tax (PIT) capacity. Proxying for development using either 84 household surveys across countries today or 140 years of historical data within-US (1870-2010), I first establish two new stylized facts: 1) within-country, employee share is increasing in through the income-distribution, and the profile moves leftward with development; 2) the PIT exemption threshold moves down the income-distribution with development such that the employee share above the threshold is high and constant. These findings are consistent with a model in which high employee share is a necessary condition for taxation and the rise in third-party income through increases in employee shares drives growth in tax capacity. To provide more conclusive evidence, I use quasi-experimental variation in industry-subsidy policies in the U.S. in the 1940-60s that generated exogenous changes in employee share. I find that the exogenous increase in employee share is associated with a lower State PIT threshold. I find that an expansion of the State PIT base is associated with an increase in personal income tax revenue and a substitution away from 'distortive' taxes, including selective sales taxes. This last finding is consistent with the model where growth in employee mass lowers the marginal cost of funds of PIT and increases tax-reliance on PIT, and leads to substitution away from distortive tax-sources that have high marginal cost of funds. My model and empirical findings therefore address both the observed increase in PIT take and the observed variation in tax-mix over levels of development.
Publisher
National Tax Association
