Thomas Le Barbanchon, Bocconi University

Taxes Today, Benefits Tomorrow

Abstract: How distortive are labor taxes that entitle workers to social benefits? I provide new empirical evidence of bunching in earnings distribution that directly support workers linking taxes and benefit. Partially unemployed claimants of the U.S. unemployment insurance program value future preserved benefits when they bunch at the kink of the benefit-withdrawal schedule. I then extend the bunching formula of Saez (2010) to a dynamic setting that accounts for the value of future benefits tied to taxation. This yields new tests of tax-benefit linkage based on bunching heterogeneity. I verify in quasi-experiments that UI extension programs that decrease the value of future benefits lead to more bunching and to lower labor supply. Last, a quantification exercise of my dynamic bunching formula provides extra support for a strong tax-benefit linkage.