The Wage Response to a Reduction in Income Tax Rates:The 2003–2009 Tax Reform in Israel

31/12/2017 |  Igdalov Sophia, Zussman Noam, Frish Roni
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This study examines the effect of a tax reform on wages. The reform implemented in Israel between 2003 and 2009 lowered the marginal income tax of individuals by 7–17 percentage points. The effect of the reform on gross wages is estimated by comparing the change in wage between individuals who experienced a marked reduction of their marginal tax and others.  We used panel data from the Income Tax Authority, including wages and tax payments of employees, and merged them with data from Labor Force Surveys.
We found that in the business sector, the elasticity of the gross reported wage relative to the net-of-tax rate (one minus the effective marginal direct tax rate) is about 0.1, within the range of elasticities found in similar studies. Between 2002 and 2009, the net-of-tax rate increased by about 13 percent; Therefore, given the estimated elasticity, the total reported gross wage in the business sector increased by approximately 1.1 percent. The three lowest quintiles did not react at all to the reduction in tax rates, but the elasticity increased with wages, reaching about 0.4 in the upper quintile. We did not find statistically significant differences in elasticity by gender, ethnicity or education. We also did not find a statistically significant reaction to the reform among public sector workers.