Do Payroll Taxes in the United States Create Bunching at Kink Points?

Abstract

Much of the literature on labor supply responsiveness to taxes studies the effects of payroll and income taxes together, usually using income tax changes to identify effects. There is less research on how individuals respond to payroll taxes specifically. Given the salience of the payroll tax relative to other income taxes, it is possible that taxpayers respond differentially than income tax elasticities may suggest. Using data from the Social Security Administration, I exploit two recent short-term changes in payroll taxes to study whether labor earnings responded. The Making Work Pay Tax Credit reduced the payroll tax by 6.2 percentage points up to $6,451 ($12,903 for couples) of earnings in 2009 and 2010. I test for bunching at this kink. In 2011, payroll taxes were reduced by 2 percentage points, changing the incentives to bunch at the taxable earnings maximum. While many papers on bunching must make assumptions on the distribution of earnings in the absence of taxes, an advantage of studying changes in payroll taxes is that it is possible to observe the distribution in different years under different tax regimes. I find evidence of bunching induced by the payroll tax changes. I estimate a tax elasticity of labor earnings of 0.08 at the taxable earnings maximum, suggests that policy proposals to raise or eliminate the payroll tax cap should consider labor supply behavioral responses to this policy. I also estimate larger responsiveness to the Making Work Pay Tax Credit.