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Abstract

This paper examines the response of husbands’' and wives’' earnings to a tax reform in which husbands' ’and wives’' tax rates changed independently, allowing me to examine the effect of both spouses’incentives on each spouse’s behavior. I compare the results to those of more simplifi…ed econometric models that are used in the typical setting in which such independent variation is not available. Using administrative panel data on approximately 11% of the married Swedish population, I analyze the impact of the large Swedish tax reform of 1990-1. I …nd that in response to a compensated fall in one spouse’s tax rate, that spouse’s earned income rises, and the other spouse’s earned income also rises. A standard econometric speci…cation, in which one spouse reacts to the other spouse’s income as if it were unearned income, yields biased coefficient estimates. Uncompensated elasticities of earned income with respect to the fraction of income kept after taxes are over-estimated by a factor of more than three, and income e¤ects are of the wrong sign. A second common speci…fication, in which overall family income is related to the family’s tax rate and income, also yields substantially over-estimated own compensated and uncompensated elasticities. Standard econometric approaches may substantially mis-estimate earnings responses to taxation.

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