This paper argues that it is essential to explicitly consider how the government spends tax revenues when assessing the effects of tax rates on aggregate hours of market work. Different forms of government spending imply different elasticities of hours of work with regard to tax rates. I illustrate the empirical importance of this point by addressing the issue of hours worked and tax rates in three sets of economies: the US, Continental Europe and Scandinavia. While tax rates are highest in Scandinavia, hours worked in Scandinavia are significantly higher than they are in Continental Europe. I argue that differences in the form of government spending can potentially account for this pattern.
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An early version of the paper was presented at the 2003 conference in honor of Prescott being award the Nemmers Prize in Economics, held at the Federal Reserve Bank of Chicago. I have benefitted from the comments of numerous seminar participants, but would like to particularly thank Robert Lucas, Ed Prescott, and Nancy Stokey, as well as two anonymous referees, Stephen Parente and Anne Villamil for useful comments. I thank the NSF for financial support.
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Rogerson, R. Taxation and market work: is Scandinavia an outlier?. Economic Theory 32, 59–85 (2007). https://doi.org/10.1007/s00199-006-0164-9
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