Congressional Budget Office

Background Paper

the congress of the united states

The Effect of Tax Changes on

Labor Supply in CBO’s

Microsimulation Tax Model

April 2007
Pub. No. 2756
The Congress of the United States O Congressional Budget Office

CBO

The Effect of Tax Changes on

Labor Supply in

CBO’s Microsimulation Tax Model

April 2007
Notes

Unless otherwise indicated, the years referred to in this paper are calendar years.

Numbers in the text and tables may not add up to totals because of rounding.

The definitions of substitution elasticity at the top of page 3 and in Table 2 were revised after 

publication (on May 8, 2007) for clarity.
Preface

This Congressional Budget Office (CBO) background paper provides details about one 

of the models that CBO uses to examine how changes in tax policies can affect the supply of 

labor to the economy. The paper explains CBO’s methodology and discusses the key assumptions that affect the model’s results. It then applies the model to a possible change in tax policy—extending many of the expiring tax provisions enacted since 2001—and estimates the 

resulting effects on the labor supply. Because the paper focuses only on labor-supply effects, 

it does not represent a complete macroeconomic analysis of that policy change. In particular, 

if the change was financed through larger budget deficits or smaller budget surpluses, the 

macroeconomic impact would be less positive than an analysis of labor-supply effects by itself 

would indicate. In keeping with CBO’s mandate to provide objective, impartial analysis, this 

paper makes no recommendations.

Edward Harris of CBO’s Tax Analysis Division wrote the paper under the direction of David 

Weiner, Roberton Williams (formerly of CBO), and Thomas Woodward. Robert Dennis, 

Douglas Hamilton, Arlene Holen, Donald Marron, and Kevin Perese provided useful comments on the analysis.

Christian Howlett edited the paper, and Kate Kelly proofread it. Maureen Costantino 

prepared the report for publication, Lenny Skutnik produced the printed copies, Linda 

Schimmel coordinated the print distribution, and Simone Thomas prepared the electronic 

versions for CBO’s Web site (www.cbo.gov).

Peter R. Orszag

Director

April 2007

Contents

Introduction 1

Ways in Which Taxes Affect the Supply of Labor 2

The Potential Tax-Policy Change That CBO Analyzed 3

How CBO Estimated Labor-Supply Effects Using Its 

Microsimulation Tax Model 3

CBO’s Tax Model 3

Assumptions About Workers’ Responses 5

The Revenue Offset from Changes in Hours Worked 7

Limitations of the Analysis 8

The Overall Labor-Supply Effects of Extending EGTRRA, 

JGTRRA, and AMT Relief 8

The Labor-Supply Effects of Extending EGTRRA, JGTRRA, and 

AMT Relief, by Provision 9

Statutory Tax Rates and Brackets 12

Child Tax Credit 13

Limits on Itemized Deductions and Personal Exemptions 14

AMT Exemption 14

Relief from Marriage Penalties 15

Tax Rates on Capital Income 15

The Labor-Supply Effects of Extending EGTRRA, JGTRRA, and 

AMT Relief, by Earnings Group 16
VI THE EFFECT OF TAX CHANGES ON LABOR SUPPLY IN CBO’S MICROSIMULATION TAX MODEL

Tables

1. Details of the Potential Tax-Policy Change That CBO 

Analyzed 4

2. CBO’s Mid-Level Assumptions About Labor-Supply 

Elasticities, by Earnings Group 6

3. Overall Effects on Labor Supply in 2011 from Extending 

EGTRRA, JGTRRA, and AMT Relief 8

4. Effects on Labor Supply in 2011 from Extending EGTRRA, 

JGTRRA, and AMT Relief, by Provision 10

5. Effects on Labor Supply in 2011 from Extending EGTRRA, 

JGTRRA, and AMT Relief, by Earnings Group 18

Figure

1. Effects on Marginal and Average Tax Rates in 2011 from

Extending EGTRRA, JGTRRA, and AMT Relief, by

Earnings Group 17

Box

1. Measures of Tax Rates 2
The Effect of Tax Changes on Labor Supply in 

CBO’s Microsimulation Tax Model

Introduction

Changes in tax policy can influence the economy, and 

those economic effects in turn can affect the federal budget. Determining the macroeconomic impact of tax policies is a complex and uncertain process; thus, conventional estimates of the budgetary effect of tax policies 

generally assume no change in economic output 

(although they incorporate various changes in people’s 

behavior in response to a policy change).1

 In some of its 

work, however, the Congressional Budget Office (CBO) 

considers the potential macroeconomic effects of tax and 

spending policies.2 When doing so, CBO uses simulations from various economic models.3

 For three of the 

models (the “textbook” growth model, the Macroeconomic Advisers model, and the Global Insight model), 

CBO uses estimates that are based on its microsimulation 

tax model as inputs. This paper provides details about 

one important part of those estimates: the effects on the 

supply of labor.

CBO’s microsimulation tax model simulates the tax code 

for a representative group of taxpayers in order to estimate the impact of tax policies on people’s willingness to 

work. This paper illustrates the methodology and results 

of that model by applying it to a possible change in tax 

policy: extending the provisions of the Economic Growth 

and Tax Relief Reconciliation Act of 2001 (EGTRRA) 

and the Jobs and Growth Tax Relief Reconciliation Act of 

2003 (JGTRRA), coupled with permanently increasing 

the exemption amount for the alternative minimum tax 

(AMT). Because those various tax provisions have widely 

differing effects on labor supply, the paper also presents 

results separately for each of the major provisions.

Although this report provides extensive detail about one 

aspect of CBO’s macroeconomic analysis, it does not represent a complete macroeconomic analysis of the policy 

change in question, for several reasons. First, it focuses 

only on the impact on labor supply, ignoring other 

macroeconomic effects of the policy change, such as 

effects on national savings. For example, if tax changes are 

financed through higher budget deficits or lower budget 

surpluses, national saving will be reduced, creating a drag 

on economic growth that is not accounted for in this 

analysis. Second, in considering labor-supply effects, the 

analysis excludes behavioral responses other than working 

more or fewer hours, such as shifting income from wages 

to benefits. Third, this paper ignores how the method of 

financing a tax change could affect labor supply and how 

taxes could influence wage rates and interest rates. Finally, 

CBO’s full macroeconomic analyses rely on results from 

several different models, whereas this paper discusses only 

the microsimulation tax model (which provides inputs 

for those macroeconomic models). 

For all of those reasons, the results in this paper should 

not be interpreted as an overall macroeconomic analysis 

of extending EGTRRA, JGTRRA, and the higher AMT 

exemption. Instead, the analysis focuses on the more 

limited issue of how those changes could alter the number of hours that people work. If the extension of those

1. The revenue effects of potential changes in tax law are estimated 

by the Congress’s Joint Committee on Taxation.

2. CBO’s baseline budget projections include the expected macroeconomic impact of current law (projecting, for example, that taxlaw changes scheduled to occur in 2011 will affect the levels of 

work and saving in the economy). CBO also regularly updates its 

economic baseline to reflect any expected effects of new laws. In 

addition, for the past several years, CBO has analyzed the potential macroeconomic effects of the President’s budgetary proposals 

as part of its annual analysis of those proposals. Finally, CBO has 

conducted macroeconomic analyses of various stylized tax and 

spending programs.

3. For information about those models, see Congressional Budget 

Office, An Analysis of the President’s Budgetary Proposals for Fiscal 

Year 2008 (March 2007), Appendix D, and How CBO Analyzed 

the Macroeconomic Effects of the President’s Budget (July 2003).
2 THE EFFECT OF TAX CHANGES ON LABOR SUPPLY IN CBO’S MICROSIMULATION TAX MODEL

tax provisions was financed through larger deficits or 

smaller surpluses, the overall macroeconomic consequences would be less positive than an analysis of laborsupply effects alone would suggest.

Ways in Which Taxes Affect the 

Supply of Labor

Changes in tax policy create two countervailing pressures 

on people’s willingness to work. Tax cuts reduce average 

tax rates, which increases the after-tax income from a 

given amount of work and allows people to maintain the 

same standard of living while working fewer hours. By 

itself, that income effect implies that a tax cut would 

decrease the number of hours that people work. At the 

same time, however, tax cuts often reduce marginal tax 

rates, which raises after-tax compensation for an additional hour of work and thereby makes work more attractive relative to other uses of a person’s time. That substitution effect by itself suggests that a tax cut would increase 

the number of hours worked. (For a description of average, marginal, and other kinds of tax rates, see Box 1.) 

Since the income and substitution effects work in opposite directions, economic theory alone generally cannot 

predict how a tax change will affect labor supply—the 

outcome depends on the relative size of the two effects. 

Different tax changes can have very different income and 

substitution effects; hence, they can lead to significantly 

differing changes in labor supply. Some tax cuts (such as 

increases in the individual income tax’s personal exemptions) raise after-tax income but have little or no impact 

on marginal rates and thus are likely to reduce labor 

supply through the income effect. Tax changes that alter 

marginal rates without affecting after-tax income (for 

instance, reductions in statutory rates financed by eliminating personal exemptions) increase the hours that people work through the substitution effect. Still other tax 

changes (such as reductions in statutory rates) affect 

marginal rates and after-tax income and thus have both 

income and substitution effects.

This paper’s analysis of how taxes affect labor supply is 

based on estimates, drawn from a review of academic 

literature, about how workers respond to changes in aftertax income and wage rates.4 Economists generally measure that responsiveness as an “elasticity.” CBO’s calculations rely on three related elasticities. The income elasticity 

measures the percentage change in total hours of work 

that would result from a 1 percent increase in the amount

Box 1.

Measures of Tax Rates

Statutory tax rates are the schedule of six tax rate 

brackets—currently 10, 15, 25, 28, 33 and 35 percent—found in the individual income tax law. For 

any taxpayer, the portion of taxable income that falls 

in a given bracket is taxed at the rate for that bracket, 

regardless of the taxpayer’s total income level.

Someone’s marginal tax rate is the percentage of an 

additional dollar of income that he or she pays in 

taxes, taking into account all aspects of tax law. For 

most taxpayers, the effective marginal rate is the same 

as the statutory marginal rate—the rate that applies 

to the last dollar of a person’s taxable income. The 

two rates can differ in some cases, however, because 

of the phasing in or out of particular tax provisions. A 

related measure, the after-tax wage rate, is the 

amount of income from working another hour that a 

taxpayer gets to keep. It equals the pretax wage rate 

times 1 minus the marginal tax rate. Analyses of tax 

changes often focus on the marginal tax rate, whereas 

substitution elasticities (described on page 3) measure 

the percentage change in hours worked for each percentage change in the after-tax wage rate.

In contrast to the marginal tax rate, the average tax 

rate equals the total amount of tax that someone pays 

divided by his or her total income. Income elasticities 

are generally measured with respect to the percentage 

change in after-tax income, which equals pretax 

income multiplied by 1 minus the average tax rate.

4. See Congressional Budget Office, Labor Supply and Taxes (January 

1996), for a more detailed discussion. 
THE EFFECT OF TAX CHANGES ON LABOR SUPPLY IN CBO’S MICROSIMULATION TAX MODEL 3

of after-tax income, holding constant the after-tax wage 

rate (see Box 1). The substitution elasticity measures the 

percentage change in hours worked from a 1 percent 

increase in the wage rate, holding the worker’s utility 

constant. The total wage elasticity is the sum of the two 

elasticities; it measures the percentage change in total 

hours of work that would result from 1 percent increases 

in both after-tax income and the after-tax wage rate. 

The Potential Tax-Policy Change 

That CBO Analyzed

The Congress and the President have enacted several 

major tax laws in recent years, many of whose provisions 

are scheduled to expire by 2011. EGTRRA lowered 

statutory rates, increased credits, and lessened the 

impact of the marriage penalty and the alternative minimum tax. JGTRRA accelerated some of the provisions 

in EGTRRA, reduced taxes on capital gains and qualified 

dividends, and temporarily raised exemption levels for 

the alternative minimum tax. The Working Families Tax 

Relief Act of 2004 also accelerated some provisions of 

EGTRRA and extended other provisions of EGTRRA 

and JGTRRA. The Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA) extended the reduced rates 

on capital gains and dividends through 2010 and 

increased the AMT exemption for 2006.

This paper compares the labor supply in 2011 under 

two alternatives for tax law. The base case is current law, 

under which recently enacted tax provisions expire as 

scheduled between now and 2011. The alternative 

envisions extending the provisions of EGTRRA and 

JGTRRA (see Table 1). That alternative is similar to the 

individual income tax extensions proposed in the President’s budget for 2008. However, the President’s proposal 

does not include any change to the AMT after 2007, 

whereas CBO’s hypothetical policy makes permanent the 

higher AMT exemption amount set by TIPRA for 2006 

and indexes that amount for inflation in later years.5

The Joint Committee on Taxation (JCT) has estimated 

the budgetary effects of a similar set of proposals. According to JCT, permanently extending the provisions of 

EGTRRA and JGTRRA (except those dealing with estate 

and gift taxes) would cost $186 billion in fiscal year 2012 

and a total of $1.4 trillion between 2008 and 2017.6

Combining that change with permanent indexation of 

the AMT for inflation would add $93 billion to that cost 

in 2012 and $1.0 trillion over the 2008–2017 period, 

JCT estimates.7

 That estimate includes the costs of 

indexing both the AMT’s tax brackets and exemption for 

inflation, whereas the policy change considered in this 

paper would index only the exemption. 

How CBO Estimated Labor-Supply 

Effects Using Its Microsimulation 

Tax Model

To estimate the impact of that possible tax change on the 

supply of labor, CBO began with a representative sample 

of taxpayers and adjusted the sample to account for 

expected demographic and economic changes by 2011. 

It then calculated taxes for each member of the sample 

under the two alternatives for tax law, determined the differences in average and marginal tax rates, and applied 

various assumed labor-supply elasticities to those differences to estimate the labor-supply effects of the policy 

change. Finally, CBO calculated taxes at the new level of 

labor supply.

CBO’s Tax Model

Data from a representative sample of income tax returns, 

constructed by the Internal Revenue Service, form the 

core of CBO’s microsimulation tax model. This analysis 

relied on a sample of almost 200,000 tax returns filed in 

2002 (the most recent year for which data were available 

when the analysis was performed). CBO augmented the 

tax return data in various ways, such as using information 

from the Census Bureau’s Current Population Survey to 

create records for households that do not file tax returns 

5. The President’s budget also contains proposals to substantially 

alter the tax treatment of health insurance. Those proposals are 

not included in this analysis. For a discussion of them, see Congressional Budget Office, An Analysis of the President’s Budgetary 

Proposals for Fiscal Year 2008, Appendix C.

6. The figure for 2012 is important because that fiscal year is the first 

that would contain the full-year cost of extending the tax provisions. See Joint Committee on Taxation, Description of Revenue 

Provisions Contained in the President’s Fiscal Year 2008 Budget 

Proposal, JCS-2-07 (March 2007).

7. See Congressional Budget Office, The Budget and Economic 

Outlook: Fiscal Years 2008 to 2017 (January 2007), Table 1-5.
4 THE EFFECT OF TAX CHANGES ON LABOR SUPPLY IN CBO’S MICROSIMULATION TAX MODEL

Table 1.

Details of the Potential Tax-Policy Change That CBO Analyzed

Continued

and using data from other sources to estimate how wage 

income is split between spouses in married couples that 

file joint returns.

Because this analysis estimates the effect of a tax change 

that would occur in 2011, but the underlying data for 

CBO’s model come from 2002, CBO “aged” the sample 

to represent the population in 2011. That process 

involved adjusting the weighting of the sample to account 

for expected changes in the composition of the population and in employment levels. CBO then increased the 

amounts of different types of income on each tax record 

to projected levels for 2011. Wages, interest, and dividends were adjusted to be consistent with CBO’s macroeconomic projections; Social Security and unemployment 

insurance benefits, to match CBO’s outlay projections for 

those programs; and capital gains and retirement income, 

to be consistent with results from other projection models. The resulting sample should be representative of U.S. 

households in 2011, contingent on the accuracy of the 

underlying demographic and economic projections.

The microsimulation tax model contains a detailed 

income tax “calculator” that CBO used to compute individual taxpayers’ liabilities for federal and state income 

taxes and federal payroll taxes under the two alternatives

Base Case: Current Law in 2011 Policy Change: EGTRRA, JGTRRA, and

Provision (EGTRRA and JGTRRA expired) AMT Relief Extended Through 2011

10 Percent Tax Bracket n.a. Applies to single filers with income up to $7,000;

 joint filers, up to $14,000; and heads of 

household, up to $10,000. Those thresholds

indexed for inflation from 2003

Higher Tax Brackets (Percent) 15.0 15.0

28.0 25.0

31.0 28.0

36.0 33.0

39.6 35.0

Child Credit Credit of $500, with limited refundability Credit of $1,000, refundable to a maximum of 

15 percent of earned income above $10,000; 

threshold indexed for inflation after 2001

Dependent Care Credit Maximum expenditure eligible for credit is Maximum expenditure eligible for credit is

$2,400 for one child, $4,800 for two or more; $3,000 for one child, $6,000 for two or more;

maximum credit is 20 percent to maximum credit is 20 percent to

30 percent of expenditures 35 percent of expenditures

Limits on Itemized Deductions Deductions are reduced by 3 percent No reduction in deductions

of amount of income above a threshold

(to a maximum reduction of 80 percent)

Personal Exemption Phaseout Value of personal exemptions is reduced No phaseout of exemptions

by 2 percent for each $2,500 of adjusted 

gross income above a threshold

Statutory Tax Rates and Brackets

Child Credit and Dependent Care Credit

Limits on Itemized Deductions and Personal Exemptions
THE EFFECT OF TAX CHANGES ON LABOR SUPPLY IN CBO’S MICROSIMULATION TAX MODEL 5

Table 1.

Continued

Source: Congressional Budget Office.

Note: EGTRRA = Economic Growth and Tax Relief Reconciliation Act of 2001; JGTRRA = Jobs and Growth Tax Relief Reconciliation Act of 

2003; AMT = alternative minimum tax; n.a. = not applicable.

for tax law.8 To calculate marginal tax rates, CBO 

increased each worker’s earnings by $1,000 and 

recomputed income and payroll taxes under each law.9

Then, to estimate the net change in labor income, CBO 

multiplied the percentage change in a worker’s after-tax 

wage rate by an assumed substitution elasticity and multiplied the percentage change in after-tax income by an 

assumed income elasticity.10

Assumptions About Workers’ Responses

On the basis of academic literature, CBO assumed that 

different types of workers respond differently to changes 

in after-tax income and wage rates.11 Research shows that 

married women are the most sensitive to those rates, with

Base Case: Current Law in 2011 Policy Change: EGTRRA, JGTRRA, and

Provision (EGTRRA and JGTRRA expired) AMT Relief Extended Through 2011

Exemption for the Alternative $33,750 for single filers, $42,500 for single filers,

Minimum Tax $45,000 for joint filers $62,550 for joint filers in 2006;

indexed for inflation thereafter

Standard Deduction for Standard deduction for joint filers is Standard deduction for joint filers is 

Joint Filers 167 percent of that for single filers 200 percent of that for single filers

15 Percent Tax Bracket for Upper threshold of bracket for joint filers is Upper threshold of bracket for joint filers is

Joint Filers 167 percent of that for single filers 200 percent of that for single filers

Earned Income Tax Credit for Income level at which credit starts to Starting and ending points of phaseout 

Joint Filers phase out is indexed for inflation; end of range are increased by $3,000 for joint filers

phaseout range depends on number of children

Tax Rate on Capital Gains 10 percent for taxpayers in the Zero for taxpayers in the

 15 percent statutory tax bracket or below; 15 percent statutory tax bracket or below; 

20 percent for other taxpayers 15 percent for other taxpayers

Tax Rate on Dividends Same as ordinary statutory tax rates Zero for taxpayers in the

 15 percent statutory tax bracket or below; 

15 percent for other taxpayers

Relief from the Alternative Minimum Tax

Relief from Marriage Penalties

Taxation of Capital Income

8. The state tax calculator that CBO used was created by Professor 

Jon Bakija of Williams College. For more details, see Jon Bakija, 

Documentation for a Comprehensive Historical U.S. Federal and 

State Income Tax Calculator Program (working paper, Williams 

College Department of Economics, April 21, 2006), available at 

www.williams.edu/Economics/papers/bakijaDocumentation_ 

IncTaxCalc.pdf.

9. Ideally, the marginal rate would be customized to measure the relevant labor-force decision. The marginal rate associated with small 

changes in hours worked may differ from the rate associated with 

larger changes, such as deciding whether to work at all, so CBO’s 

approach may misstate the rate that is relevant to taxpayers who 

are making more-basic labor-force decisions.

10. CBO used an arc elasticity formula, applying the elasticity to the 

midpoint between the beginning and ending after-tax rates.

11. For a summary of that literature, see Congressional Budget Office,

Labor Supply and Taxes (January 1996).
6 THE EFFECT OF TAX CHANGES ON LABOR SUPPLY IN CBO’S MICROSIMULATION TAX MODEL

Table 2.

CBO’s Mid-Level Assumptions About 

Labor-Supply Elasticities, by Earnings 

Group

Source: Congressional Budget Office.

Notes: Income elasticity measures the percentage change in total 

hours worked that would result from a 1 percent increase in 

after-tax income, holding the after-tax wage rate constant. 

Substitution elasticity measures the percentage change in 

hours worked from a 1 percent increase in the after-tax 

wage rate, holding the worker’s utility constant. The total 

wage elasticity is the sum of the two elasticities; it measures 

the percentage change in hours worked that would result 

from 1 percent increases in both after-tax income and the 

after-tax wage rate. 

CBO assigned an elasticity to each worker in 2002, the base 

year of the data. Each worker’s elasticity was held constant 

for the 2002–2011 projection period, so as CBO’s model 

“aged” the data, adjusting for demographic changes and 

assumed changes in the wage distribution, the aggregate 

elasticity changed slightly.

a. A decile is a tenth of the distribution of workers ordered by 

annual earnings.

much of their response taking the form of choosing 

whether to participate in the labor force.12 Less evidence 

exists on how unmarried women react to changes in their 

after-tax income and wage rates. Among men, research 

shows that lower-income workers are more sensitive to 

those changes than higher-income workers are.13 Because 

CBO’s sample of taxpayers does not contain consistent 

information about the sex of workers, CBO used mens’ 

labor-supply elasticity for “primary earners”—either single taxpayers or higher-earning spouses in married couples. That method assumed that single female workers 

would have the same response as men. Similarly, CBO 

applied the labor-supply elasticity for married women to 

all “secondary earners”—the lower-earning spouses in 

married couples—thus assuming that male secondary 

earners would have the same response as married women.

In CBO’s assumptions, the average worker has a total 

wage elasticity of 0.129, implying that 10 percent 

increases in both after-tax income and the after-tax wage 

rate would cause a 1.29 percent increase in hours worked. 

That total elasticity equals the sum of an income elasticity 

of -0.101 and a substitution elasticity of 0.229 (see 

Table 2). For the average primary earner, CBO assumed a 

total wage elasticity of 0.07, the sum of an income elasticity of -0.07 and a substitution elasticity of 0.14. That 

average masks significant variation by earnings group. For 

example, primary earners in the lowest decile of the earnings distribution were assumed to have a total wage elasticity of 0.168, compared with just 0.028 for primary 

earners in the top four deciles.14 Secondary earners were 

assigned a total wage elasticity of 0.40, the sum of an 

income elasticity of -0.25 and a substitution elasticity 

of 0.65.15

12. CBO does not explicitly model the decision to participate in the 

labor force, instead incorporating that decision into the elasticity 

for hours worked and applying that (higher) elasticity to workers.

-0.101 0.229 0.129

-0.062 0.141 0.079

-0.070 0.140 0.070

-0.038 0.076 0.038

Lowest decile -0.168 0.336 0.168

Second decile -0.126 0.252 0.126

Third and fourth deciles -0.084 0.168 0.084

Fifth and sixth deciles -0.063 0.126 0.063

Top four deciles -0.028 0.056 0.028

-0.250 0.650 0.400

Primary Earners

By earnings groupa

Elasticity Elasticity

Income Substitution Wage

All Earners

Elasticity

Secondary Earners

Total

Person-weighted

Earnings-weighted 

Person-weighted

Earnings-weighted 

13. However, some studies of the effect of taxes on taxable income, 

which consider a much broader array of behavioral responses, have 

found the largest response among high-income taxpayers. For a 

discussion of that research, see Seth H. Giertz, Recent Literature on 

Taxable-Income Elasticities, CBO Technical Paper 2004-16 

(December 2004).

14. CBO’s assumptions about elasticities by earnings group are based 

on Chinhui Juhn, Kevin M. Murphy, and Robert H. Topel, “Current Unemployment, Historically Contemplated,” Brookings 

Papers on Economic Activity, no. 1 (2002).

15. In some earlier analyses, CBO assumed a higher total wage elasticity (0.5) and substitution elasticity (0.75) for secondary earners. 

CBO has lowered those estimates on the basis of evidence that secondary earners have become less responsive over time as their participation in the labor force has grown. See Francine D. Blau and 

Lawrence M. Kahn, Changes in the Labor Supply Behavior of Married Women: 1980-2000, Working Paper No. 11230 (Cambridge, 

Mass.: National Bureau of Economic Research, March 2005).
THE EFFECT OF TAX CHANGES ON LABOR SUPPLY IN CBO’S MICROSIMULATION TAX MODEL 7

Translating a change in hours worked into a change in 

total earnings requires weighting each worker’s change in 

labor supply by his or her wage. That earnings-weighted 

elasticity—the elasticity that can be used to compute the 

change in total labor income rather than in hours 

worked—is smaller than the person-weighted elasticities 

cited above because CBO assumes that higher-earning 

workers are less sensitive than lower-income workers to 

changes in after-tax income and wage rates. The personweighted total wage elasticity of 0.129, coupled with 

CBO’s different elasticities by earnings group, produces 

an earnings-weighted total wage elasticity of 0.079. 

Those two elasticities imply that 10 percent growth in 

both after-tax income and the after-tax wage rate would 

lead to a 1.29 percent increase in hours worked and a 

0.79 percent rise in economywide wage income.

Because this analysis measures the macroeconomic effects 

of the potential tax-policy change in dollar terms, the 

earnings-weighted elasticity is a more important factor 

than the person-weighted elasticity. The fact that highincome taxpayers make a large contribution to earningsweighted elasticities is a potential source of uncertainty in 

the analysis, since few studies have directly considered 

those workers’ responsiveness to changes in their wage 

rates.16

The assumptions about labor-supply elasticity drive the 

results of this analysis, but a great deal of uncertainty surrounds the proper measurement of that elasticity. Academic studies reach no consensus about the size of the 

elasticity, reporting a wide range of estimates. To evaluate 

how such uncertainty might affect the results of this analysis, CBO also made higher and lower assumptions about 

the average worker’s total wage elasticity. The higher 

assumption raised the average earnings-weighted total 

wage elasticity by roughly 90 percent (from 0.079 to 

0.150), while the lower assumption reduced it by 90 percent (from 0.079 to 0.009). That range covers what CBO 

believes to be the plausible span of labor-supply elasticity 

estimates based on its review of the academic literature.

The Revenue Offset from Changes in Hours Worked

To help put the labor-supply effect in context, CBO calculated how much of the initial revenue loss from the 

potential tax change would be offset by changes in 

income and payroll tax revenues stemming from taxpayers’ altering their work hours. That revenue offset 

differs in several important ways from the revenue offsets 

presented in other CBO analyses, including the recent 

analysis of the President’s 2008 budget.

B As noted above, the tax change that is the focus of this 

analysis differs from the President’s proposals by 

including a higher AMT exemption amount that is 

indexed for inflation.

B The revenue offset in this analysis reflects only the 

shifts in labor supply, not other macroeconomic 

effects of the policy change, such as effects on national 

savings. For example, to the extent that the tax change 

was financed through bigger deficits or smaller surpluses, the revenue offset would tend to be smaller (or 

more negative) than shown here because the lower 

level of national saving associated with larger deficits 

or smaller surpluses would restrain economic activity, 

reducing tax revenues by more than an estimate 

excluding such macroeconomic effects would indicate.

B Likewise, the analysis ignores how the means of 

financing the tax change would affect the supply of 

labor. 

B The revenue offset in this analysis was calculated as a 

percentage of a completely static revenue loss (computed by simply applying the policy change to initial 

income levels), not as a percentage of a conventional 

revenue estimate.17

B This analysis computed the revenue offset separately 

for each worker, applying that worker’s marginal tax 

rate to his or her change in labor supply. In contrast, 

CBO’s analysis of the President’s budget applied one 

aggregate tax rate to the economywide change in labor 

supply. 16. Most studies rely on survey data, which generally contain too few 

high-income taxpayers to accurately represent that population. 

CBO assumed that all taxpayers in the top four earnings deciles 

would have the same response, but if labor-supply elasticity 

instead varied across the upper part of the earnings distribution, 

labor-supply effects could differ significantly from those presented 

here.

17. In contrast, the conventional revenue estimates of tax proposals 

calculated by JCT generally incorporate behavioral responses by 

taxpayers that can occur without altering the level of gross 

national product, such as changes in the form and timing of 

income and deductions, or changes in tax compliance.
8 THE EFFECT OF TAX CHANGES ON LABOR SUPPLY IN CBO’S MICROSIMULATION TAX MODEL

Table 3.

Overall Effects on Labor Supply in 

2011 from Extending EGTRRA, 

JGTRRA, and AMT Relief

Source: Congressional Budget Office.

Notes: This analysis compares current law, under which the provisions of EGTRRA and JGTRRA expire as scheduled by the end 

of 2010, with an alternative in which those provisions and 

increases in the exemption amount for the AMT are 

extended. The estimates use CBO’s mid-level assumptions 

about labor-supply elasticities (shown in Table 2). Tax rates 

include federal and state individual income taxes and payroll 

taxes. Marginal tax rates are weighted by earnings; average 

tax rates are weighted by total income.

EGTRRA = Economic Growth and Tax Relief Reconciliation 

Act of 2001; JGTRRA = Jobs and Growth Tax Relief Reconciliation Act of 2003; AMT = alternative minimum tax.

The revenue offset also includes revenue effects from offsetting labor-supply changes that are not captured in a 

net measure of labor supply. Provisions of EGTRRA and 

JGTRRA that cause some people to work more and others to work less affect revenues beyond the impact on net 

labor supply to the extent that those workers face different tax rates.

Limitations of the Analysis

As noted above, this analysis is focused on a limited issue: 

the impact of a potential tax-policy change on hours 

worked. It does not represent a full macroeconomic analysis, which would need to reflect several other key factors, 

such as the method of financing the change. Furthermore, people respond to tax changes in ways other than 

working more or fewer hours. Some workers might shift 

income between taxable and nontaxable forms, and some 

might simply change how much income they report to 

the Internal Revenue Service—effects that are included 

in conventional revenue estimates. Other people might 

choose to work harder or to pursue further education, 

although little empirical evidence exists about the size of 

those effects.

This analysis compares steady-state levels of labor supply 

under two different tax regimes without considering how 

the economy would move from one to the other or how 

long that transition would take.18 In reality, people 

would not shift instantly to their newly desired number 

of work hours after a tax change. However, there is little 

evidence about how long such a transition would last. In 

part, the length of the transition would depend on 

whether workers anticipated the tax change. 

The Overall Labor-Supply Effects of 

Extending EGTRRA, JGTRRA, and 

AMT Relief

Looking only at the impact on hours worked, CBO estimates that extending the provisions of EGTRRA and 

JGTRRA and increasing the AMT exemption would 

raise total earnings in 2011 by 0.55 percent—or about 

$42 billion—under the mid-level assumptions about 

labor-supply elasticities (see Table 3). The substitution 

effect from lower marginal tax rates would boost earnings 

by 0.80 percent, while the income effect from higher 

0.55

41.9

-2.3

-1.7

___

Total -4.0

 30.1

27.0

Difference (Percentage points) -3.1

4.5

-0.25

-0.055

 41.6

38.4

Difference (Percentage points) -3.2

5.5

0.80

0.144

Average Tax Rate (Percent)

Under current law, with EGTRRA and JGTRRA expired

Under those laws' extension

Change in After-Tax Income (Percent)

Change in After-Tax Wage Rate (Percent)

Change in Earnings (Percent)

Effective Substitution Elasticity (Percentage change in 

earnings per percentage rise in after-tax wage rate)

Change in Earnings

Revenue Offset (As a percentage of revenue loss)

Marginal Tax Rate (Percent)

Percent

Billions of 2011 dollars

Income tax offset

Payroll tax offset

Under current law, with EGTRRA and JGTRRA expired

Under those laws' extension

Total Effect

Substitution Effect

in 2011

Impact

Income Effect

Change in Earnings (Percent)

Effective Income Elasticity (Percentage change in 

earnings per percentage rise in after-tax income)

18. CBO’s analysis of the President’s budget made explicit assumptions about how long such a transition would take.
THE EFFECT OF TAX CHANGES ON LABOR SUPPLY IN CBO’S MICROSIMULATION TAX MODEL 9

after-tax income would reduce earnings by 0.25 percent. 

The substitution effect outweighs the income effect 

because the change in the after-tax wage rate would 

exceed the change in average after-tax income and 

because CBO assumes that the substitution elasticity is 

more than twice as large as the income elasticity.

The additional earnings from extending those tax provisions would in turn increase income and payroll tax revenues, offsetting a modest share of the static effect of the 

policy change. At the same time, the extension would 

shift earnings, causing some people to increase the hours 

they worked while others reduced their hours. CBO estimates that the change in tax revenues from the shift in 

labor supply would offset roughly 4 percent of the static 

revenue loss. Of that 4 percent, about 2.3 percentage 

points would come from higher income tax revenues and 

1.7 percentage points from increased payroll tax revenues.19 (State income tax revenues would also rise, but 

CBO did not calculate that effect because its models and 

sample are not designed to estimate tax changes at the 

state level.)

Extending the tax provisions would lower the earningsweighted marginal tax rate by 3.2 percentage points and 

raise the after-tax return from additional work (the 

after-tax wage rate) by 5.5 percent. For each 1 percent 

increase in the after-tax wage rate, earnings would rise 

by 0.144 percent. That effective elasticity is just above 

CBO’s assumed earnings-weighted substitution elasticity 

of 0.141 because extending the tax provisions would 

boost after-tax wage rates to a greater extent for moreresponsive taxpayers than for less-responsive taxpayers, on 

average. (If the provisions increased after-tax wage rates 

by an equal percentage for all groups, the effective elasticity would equal the earnings-weighted elasticity.) 

At the same time, the tax change would decrease the average tax rate by 3.1 percentage points, thus raising aftertax income by 4.5 percent. That increase in after-tax 

income would induce taxpayers to reduce their earnings 

by 0.25 percent—or 0.055 percent for each 1 percent 

change in after-tax income. That effective income elasticity is smaller than CBO’s assumed earnings-weighted 

income elasticity of 0.062 because extending the tax 

provisions would boost after-tax income for lessresponsive taxpayers (such as primary earners) to a lesser 

extent than it would for more-responsive taxpayers (such 

as secondary earners).

Because measurements of labor-supply elasticity are 

uncertain, CBO recalculated those results using alternative assumptions, with the earnings-weighted total wage 

elasticity roughly 90 percent higher or lower (0.150 or 

0.009 rather than 0.079). The higher elasticity assumption raised the estimated total effect on earnings by about 

60 percent, from a 0.55 percent increase to a 0.90 percent 

increase. The lower elasticity assumption reduced that 

effect by about 70 percent, to a 0.15 percent increase. 

Under both the higher and lower elasticity assumptions, 

the change in the income effect is roughly proportional to 

the assumed change in income elasticity, and the change 

in the substitution effect is roughly proportional to the 

assumed change in substitution elasticity. The net change 

in labor supply, however, is not proportional to the 

change in total wage elasticity, because the relative importance of the income and substitution effects for the total 

wage effect differs from the relative importance of the 

income and substitution elasticities for the total wage 

elasticity.

The Labor-Supply Effects of Extending 

EGTRRA, JGTRRA, and AMT Relief, by 

Provision

Taken individually, the various tax provisions that CBO 

examined have differing effects on labor supply, for many 

reasons. At the most basic level, the size of a tax change 

influences its impact: Bigger changes can cause larger 

shifts in labor supply. In addition, the structure of a tax 

change plays a critical role in determining its labor-supply 

effect. Although the cost of a provision corresponds 

directly to the income effect on the average tax rate, 

provisions with comparable costs can have very different 

impacts on marginal tax rates and thus widely varying 

substitution effects. Finally, the distribution of a tax 

change among taxpayers influences its labor-supply 

effect. Policies that target secondary earners, whom CBO 

believes are the most responsive to tax changes, will cause 

greater changes in labor supply than will policies that 

affect higher-wage primary earners, whom CBO considers the least responsive.

The revenue offset (the change in tax revenues caused by 

the change in total earnings) also varies among the tax 

19. As noted above, those revenue-offset figures would be different 

under a full macroeconomic analysis of the tax-policy change.
10 THE EFFECT OF TAX CHANGES ON LABOR SUPPLY IN CBO’S MICROSIMULATION TAX MODEL

Table 4.

Effects on Labor Supply in 2011 from Extending EGTRRA, JGTRRA, and 

AMT Relief, by Provision

Continued

provisions, over and above the effects caused by the net 

change in labor supply. In part, that variation occurs 

because the amount of tax paid on additional earnings 

depends on how the tax change is distributed among taxpayers who face different marginal tax rates. Offsetting 

labor-supply effects can also cause the revenue offset to 

vary among the provisions. Provisions that cause some 

taxpayers to work more and others to work less can alter 

revenues but have little impact on net labor supply if 

those taxpayers face different tax rates. 

0.55 0.60 -0.06 0.11 -0.01 0.16 -0.01

-0.25 -0.15 -0.03 -0.02 -0.04 -0.04 -0.01

0.80 0.75 -0.03 0.13 0.03 0.21 *

0.14 0.26 -0.17 0.33 -0.02 0.32 -0.01

-0.06 -0.06 -0.09 -0.05 -0.08 -0.08 -0.02

0.20 0.32 -0.09 0.38 0.06 0.40 0.01

-4.0 -9.0 10.3 -13.1 6.0 -8.5 0.6

-3.14 -1.81 -0.27 -0.26 -0.36 -0.40 -0.45

4.50 2.58 0.39 0.36 0.52 0.57 0.64

4.83 2.81 0.37 0.42 0.73 0.91 0.47

3.16 1.56 0.75 0.05 0.11 0.38 0.41

4.59 2.78 0.27 0.46 0.65 0.60 0.50

-0.055 -0.058 -0.079 -0.047 -0.071 -0.076 -0.015

100.00 100.00 100.00 100.00 100.00 100.00 100.00

10.68 11.00 10.43 8.41 15.82 18.22 5.36

16.13 13.94 44.68 2.94 4.40 14.24 14.95

65.06 68.70 44.25 84.84 76.17 60.60 52.86

8.14 6.36 0.65 3.81 3.61 6.94 26.83

Tax Rates on

Capital

Income

Labor Supply Effects

Minimum

Tax

Relief from 

Marriage

Penalties

Child

Relief from

the

and Alternative

Deductions

Itemized

Limits on

Personal

(Percentage points)

Static Revenue Cost

Percentage Change in Earnings

revenue loss)

Revenue Offset (As a percentage of 

Distribution of Tax Cut (Percent)a

Low elasticity (Primary earners in

top four deciles)

change in earnings per percentage rise 

in after-tax income)

Percentage Change in After-Tax Income

High elasticity (Secondary earners)

Middle elasticity (Primary earners in

first through sixth deciles)

Effective Income Elasticity (Percentage 

Income effect

Substitution effect

Income effect

Change in Earnings per Dollar of 

All

Provisions Credit Exemptions

Statutory

High elasticity (Secondary earners)

Middle elasticity (Primary earners in

first through sixth deciles)

Substitution effect

Change in Average Tax Rate

Low elasticity (Primary earners in

top four deciles)

Nonearners

Tax Rates

and

Brackets

Factors Affecting the Income Effect
THE EFFECT OF TAX CHANGES ON LABOR SUPPLY IN CBO’S MICROSIMULATION TAX MODEL 11

Table 4.

Continued

Source: Congressional Budget Office.

Notes: This analysis compares current law, under which the provisions of EGTRRA and JGTRRA expire as scheduled by the end of 2010, with 

an alternative in which those provisions and increases in the exemption amount for the AMT are extended. The analysis always 

extends the higher AMT exemption first. For other provisions, the analysis shows the effects if that provision was extended alone, after 

the AMT exemption.

The estimates use CBO’s mid-level assumptions about labor-supply elasticities (shown in Table 2). Tax rates include federal and state 

individual income taxes and payroll taxes. Marginal tax rates are weighted by earnings; average tax rates are weighted by total income.

EGTRRA = Economic Growth and Tax Relief Reconciliation Act of 2001; JGTRRA = Jobs and Growth Tax Relief Reconciliation Act of 

2003; AMT = alternative minimum tax; * = between zero and 0.01.

a. For couples filing joint returns, the tax change is split between spouses in proportion to their earnings.

Extending EGTRRA’s reductions in statutory tax rates—

the largest part of the law—would have the biggest 

impact on total earnings, raising them by 0.60 percent 

in 2011 (see the top of Table 4). Extending the law’s 

marriage-penalty relief would increase earnings in that 

year by 0.16 percent, and eliminating the phaseouts of 

itemized deductions and personal exemptions would 

boost earnings by 0.11 percent. In contrast, continuing 

the higher child tax credit would cause labor income to 

shrink by a small amount, 0.06 percent. Extending the

-3.23 -2.86 0.07 -0.49 -0.13 -0.60 -0.03

-1.05 -1.62 0.25 -1.97 -0.37 -1.53 -0.06

5.54 4.89 -0.11 0.84 0.22 1.03 0.04

9.48 7.76 15.12 3.62 10.93 16.04 1.78

-6.59 -2.05 -10.47 -3.76 -6.61 -4.85 -0.75

100.00 100.00 100.00 100.00 100.00 100.00 100.00

67.73 77.96 14.78 91.10 39.82 15.33 25.80

22.98 18.52 68.45 8.43 15.42 80.16 62.58

9.29 3.52 16.76 0.47 44.76 4.51 11.62

0.144 0.153 0.268 0.149 0.116 0.202 0.106

0.140 0.145 0.156 0.139 0.155 0.186 0.121

0.170 0.182 0.178 0.159 0.172 0.179 0.153

Provisions Brackets Credit Exemptions Tax Penalties Income

Relief from Tax Rates on

All and Child Personal Minimum Marriage Capital

Deductions the

Tax Rates and Alternative

Taxpayers with lower marginal rates

Taxpayers with higher marginal rates

(Percentage points)

Wage Rate

or nonearners

Statutory

Taxpayers with no change 

Taxpayers with lower marginal rates

Effective Substitution Elasticity 

(Percentage change in earnings per 

Change in Marginal Tax Rate

$100 Billion of Tax Cut

Change in Marginal Tax Rate per 

Taxpayers with higher marginal rates

Percentage Change in After-Tax 

Distribution of Tax Cut by Type of 

Change in Marginal Rate (Percent)

percentage rise in after-tax wage rate)

Taxpayers with lower marginal rates

Factors Affecting the Substitution Effect

Limits on

Itemized Relief from

Taxpayers with higher marginal rates
12 THE EFFECT OF TAX CHANGES ON LABOR SUPPLY IN CBO’S MICROSIMULATION TAX MODEL

lower rates on capital income or the increased AMT 

exemption would have almost no effect on labor 

supply.20

Scaling each provision’s effect on earnings to its cost alters 

those rankings. Repealing the phaseouts of exemptions 

and deductions would have the largest effect relative to its 

cost, boosting earnings by 33 cents for each dollar of tax 

cut. Marriage-penalty relief would be a close second with 

a 32-cent increase. The reductions in statutory tax rates 

would have smaller effects per dollar of tax change, 

inducing 26 cents of additional labor income per dollar 

of tax cut. The AMT exemption and lower rates on capital income would have small negative effects, shrinking 

earnings by 2 cents and 1 cent per dollar of tax reduction, 

whereas the child tax credit provision would cause labor 

income to fall by 17 cents for every additional dollar of 

the credit.

Revenue offsets follow approximately the same pattern as 

changes in labor income (when the analysis is limited 

solely to the feedback from labor supply, as opposed to 

other macroeconomic forces, including national savings). 

Repealing the phaseouts would have the greatest effect, 

producing enough revenue to offset 13.1 percent of the 

static cost of repeal. Additional revenue from extending 

marriage-penalty relief and the statutory tax rate provisions would offset 8.5 percent to 9.0 percent of their 

costs. The revenue offset for capital income taxes would 

be close to zero, while the change in labor supply caused 

by the larger child credit and the higher AMT exemption 

would add 10.3 percent and 6.0 percent, respectively, to 

those provisions’ costs.

Statutory Tax Rates and Brackets

EGTRRA reduced all statutory tax rates above the 

15 percent bracket and created a new bottom bracket, 

lowering the tax rate on some income from 15 percent to 

10 percent. Any taxpayer facing the regular rate schedule 

would see his or her average tax rate fall if those provisions of EGTRRA were extended. (Tax liability would be 

unchanged for families who faced the AMT in either 

case, who had no taxable income, or whose taxes were 

completely offset by nonrefundable tax credits.) Extending those rate provisions would also lower the marginal 

tax rate for most taxpayers. Everyone in a tax bracket 

above 15 percent and people in the new 10 percent 

bracket would generally experience reductions in their 

marginal rates. Marginal rates would be unchanged for 

taxpayers in the 15 percent bracket, those subject to the 

AMT, and people without positive income tax liability. 

Marginal rates would rise for some taxpayers, however, as 

the new tax rates lowered their ordinary income tax liability and thus pushed them onto the AMT, where they 

would generally face higher marginal rates.

Extending EGTRRA’s tax rate reductions would boost 

earnings in 2011 by 26 cents per dollar of tax cut—one 

of the larger effects among the individual provisions. 

That figure reflects a substitution effect of 32 cents per 

dollar of tax cut and an income effect of -6 cents. Additional tax revenues generated by the increase in earnings 

would offset 9 percent of the static cost of extending the 

tax rate provisions. 

The average taxpayer’s after-tax income would rise 

by 2.6 percent in 2011 if those rate provisions were 

extended, leading to an income effect that would shrink 

earnings by 0.15 percent (or 6 cents per dollar of tax cut). 

For each 1 percent increase in after-tax income, earnings 

would drop by 0.058 percent—an effective income elasticity just below CBO’s earnings-weighted income elasticity of 0.062. EGTRRA’s tax rate provisions would generally raise after-tax income more for people in higher 

brackets, which disproportionately include families with 

two earners or a high-earning primary worker. By giving 

the largest income increases to the most and least elastic 

taxpayers (secondary earners and high-earning primary 

earners)—effects that would tend to offset each other—

the extended rates would have an impact on labor supply 

that was comparable to that of an across-the-board 

increase in after-tax income.

Because they directly affect marginal rates, EGTRRA’s 

rate reductions would produce one of the largest substitution effects of the provisions considered in this analysis 

(32 cents of additional earnings per dollar of tax cut). 

20. Because some of the tax provisions interact, the effect attributed to 

each provision depends on the order in which they are implemented. CBO’s analysis extends the larger AMT exemption first 

and assumes that other provisions are extended individually thereafter. That approach minimizes the impact of the AMT on the 

measured effects of the other provisions. Interactions among provisions other than the AMT exemption are captured only in the 

results for extending the tax provisions as a whole. Those overall 

results are smaller than the sum of the results for the individual 

provisions because of such interactions, especially between the 

statutory tax rates and both marriage-penalty relief and the 

elimination of phaseouts for itemized deductions and personal 

exemptions.
THE EFFECT OF TAX CHANGES ON LABOR SUPPLY IN CBO’S MICROSIMULATION TAX MODEL 13

The reductions would decrease marginal rates for most 

taxpayers, with almost 80 percent of the total tax cut 

going to people who would see their marginal rates fall 

and less than 4 percent going to taxpayers who would see 

their rates rise. Those changes to statutory tax rates would 

therefore lead marginal rates to fall by more than any of 

EGTRRA’s other provisions and would cause one of the 

largest drops per dollar of tax cut. For each 1 percent rise 

in their after-tax wage rate, workers would increase their 

earnings by 0.153 percent—an effective substitution 

elasticity slightly higher than CBO’s earnings-weighted 

substitution elasticity of 0.141. 

Child Tax Credit

EGTRRA doubled the child credit to $1,000 per child 

and made it refundable, so taxpayers who owe no taxes 

can claim the credit if their earnings exceed a threshold. If 

those changes were extended, virtually every family who 

claimed the credit, as well as some who would be newly 

eligible, would see their average tax rate fall. 

For most taxpayers, extending the larger credit would 

reduce their tax liability without altering their tax bracket 

or marginal rate. Some lower-income taxpayers would see 

their marginal rate decline, however—either because they 

would receive a refundable credit at a rate of 15 percent 

on additional earnings, or because the larger credit would 

eliminate their income tax liability altogether, reducing 

their marginal rate to zero. At the same time, the larger 

credit would increase marginal rates for some highincome taxpayers by phasing out over a wider income 

range. If the child credit provisions were extended, people 

with income in that range (who would have received no 

credit without EGTRRA) would face the credit phaseout 

rate of 5 percent in addition to their statutory marginal 

tax rate.

Extending the child credit would reduce total earnings by 

0.06 percent in 2011, or by 17 cents per dollar of tax cut. 

That figure partly reflects the largest income effect of any 

EGTRRA provision relative to its size: a decline in labor 

income of almost 9 cents for each dollar of tax reduction. 

In addition, because the larger child credit is the only 

provision that, on balance, increases marginal rates, 

extending it would produce a substitution effect that 

would reduce earnings by another 9 cents per dollar of 

tax cut. The impact on tax revenues from that decline in 

labor income would raise the static cost of extending the 

child credit by 10.3 percent.

The child credit has the largest estimated income effect 

because it is more targeted than other provisions are 

toward highly responsive families. The credit phases out 

for single filers with income above $75,000 and joint filers with income above $110,000, meaning that higherincome taxpayers are ineligible for it. Also, because taxpaying families with children are likely to have at least 

one earner, the expanded child credit is the EGTRRA 

provision most targeted toward earners (nonearners 

would receive less than 1 percent of the tax cut from 

extending it). Finally, families with children have a high 

proportion of secondary earners. Because of that distribution, extending EGTRRA’s changes to the credit would 

cause workers to reduce their earnings by 0.079 percent 

for each 1 percent increase in after-tax income—the largest effective income elasticity of any provision in this 

analysis.

In addition, extending the larger child credit would, on 

balance, raise the overall earnings-weighted marginal tax 

rate, leading to a substitution effect that would further 

reduce labor income. That effect (-9 cents per dollar of 

tax cut) is among the smaller substitution effects, because 

extending the higher credit would have no impact on 

marginal rates for most taxpayers. About 68 percent of 

the tax reduction would go to taxpayers who would see 

no change in their marginal rates; the rest would be split 

roughly equally between taxpayers whose rates would rise 

and those whose rates would fall. In general, the rate cuts 

would exceed the rate increases, but the taxpayers facing 

rate increases earn much more than those facing rate 

decreases, producing a net rise in the earnings-weighted 

tax rate. The response to the rate increases would further 

exceed the response to the rate decreases because a higher 

proportion of secondary earners are affected by the 

credit’s phaseout than by its refundability.

The estimated revenue offset from extending the child 

credit provisions—in this case not an offset but an additional revenue loss of more than 10 percent—is larger 

than for most other provisions in this analysis, even 

though the child credit has a relatively small effect on 

labor supply. The various effects on marginal rates from 

extending the larger credit would cause a shift in earnings 

from high-income, high-tax families to low-income, lowtax families. That shift would reduce tax revenues while 

having offsetting effects on labor income. 
14 THE EFFECT OF TAX CHANGES ON LABOR SUPPLY IN CBO’S MICROSIMULATION TAX MODEL

Limits on Itemized Deductions and 

Personal Exemptions

Before EGTRRA was enacted, tax law reduced the total 

itemized deductions that taxpayers could claim by 3 percent of the amount of their income above a threshold (up 

to a maximum reduction of 80 percent). Similarly, the 

size of the personal exemption was reduced by 2 percent 

for each $2,500 of income above another threshold (to 

the point at which the exemption was eliminated).

Certain provisions of EGTRRA temporarily eliminate 

the phasing out of itemized deductions and personal 

exemptions. Extending those provisions would cut average tax rates for any taxpayer affected by the phaseouts (in 

2011, people with income of at least $170,000, depending on their filing status). In addition, because the phaseouts raise marginal tax rates in the income ranges to 

which they apply, eliminating them would lower marginal rates for most taxpayers in those ranges. Only 

taxpayers who had reached the end of the phaseout 

ranges—losing all of their exemptions or 80 percent of 

their itemized deductions—would experience no change 

in their marginal rates, although they would still see their 

average tax rates fall.

Eliminating the phaseouts would increase earnings in 

2011 by 0.11 percent, or 33 cents per dollar of tax cut. 

The latter effect—the largest among EGTRRA’s provisions—results from a combination of one of the smallest 

income effects (-5 cents per dollar of tax cut) and one of 

the largest substitution effects (38 cents per dollar of tax 

cut). Moreover, because of the sizable impact on earnings 

and the fact that the additional earnings would accrue to 

high-income workers, who face high marginal tax rates, 

eliminating the phaseouts would have the biggest revenue 

offset of any provision, reducing the static cost of the tax 

change by 13.1 percent.

The income effect from not limiting itemized deductions 

and personal exemptions would be small because the 

policy would mostly have an impact on high-income taxpayers, who are less responsive to tax changes. Although 

many two-earner couples would be affected, the concentration of the benefits among high-earning primary workers would drive down the effective income elasticity to 

below-average levels. 

Eliminating the phaseouts would have a large substitution effect, however, despite the skewed distribution 

toward low-elasticity workers. The reason is that more 

than 90 percent of the tax cut would go to taxpayers who 

would see their marginal rates fall and who thus would 

have a substitution effect. Because of that targeting, eliminating the phaseouts would be the most cost-effective 

way to lower effective marginal tax rates, reducing them 

by about 2 percentage points per $100 billion of static tax 

change. That effect would more than compensate for the 

low elasticity caused by the distribution of the tax change, 

creating a large substitution effect.

AMT Exemption

In the potential tax-policy change that CBO examined, 

the larger exemption amount for the alternative minimum tax that was set by TIPRA would be made permanent and indexed for inflation after 2006. That action 

would benefit all taxpayers subject to the AMT who had 

not reached the end of the phaseout range for the exemption. It would also lower taxes for some taxpayers by 

pushing their AMT liability below their ordinary income 

tax liability, causing them to move from the AMT back to 

the regular income tax. Those taxpayers would generally 

see their marginal rates fall, because effective marginal 

rates are usually higher under the AMT than under the 

ordinary income tax schedule. At the same time, the 

larger exemption would phase out over a wider range of 

income, so taxpayers with income in the new part of that 

range would see their marginal rates rise.

Extending the larger AMT exemption would cause labor 

income to decline in 2011 by 2 cents for every dollar of 

the tax change. That effect would occur because the substitution effect would be too small to offset the income 

effect. The main reason for the small substitution effect is 

that the AMT exemption has a very small net impact on 

marginal tax rates (larger only than the child credit and 

the reduced tax rates on capital income.) Extending the 

larger AMT exemption would be almost as likely to 

increase marginal rates as to decrease them, with 45 percent of the tax cut going to taxpayers whose rates would 

rise and 40 percent going to taxpayers whose rates would 

fall.21 Those effects largely offset each other, yielding a 

small net decrease in marginal tax rates and thus a small 

substitution effect from that change.

21. Because the size of those two effects depends critically on the 

nominal distribution of income, the substitution effect from 

extending the larger AMT exemption could vary substantially 

depending on the year being projected.
THE EFFECT OF TAX CHANGES ON LABOR SUPPLY IN CBO’S MICROSIMULATION TAX MODEL 15

The change in tax revenue from the larger AMT exemption exceeds the change in earnings. Although extending 

that provision would have a small net impact on earnings, 

it would prompt larger shifts of labor income from hightax to low-tax workers. Those who experienced declines 

in their marginal rates (taxpayers no longer subject to 

the AMT) would pay tax at a lower rate than those who 

experienced increases in marginal rates (taxpayers with 

income in the new, longer phaseout range for the AMT 

exemption). Consequently, tax revenues would decline 

even though the net effect on labor supply would be 

small.

Relief from Marriage Penalties

EGTRRA made several changes to reduce taxes for married couples who file joint returns. It increased the standard deduction for those couples to double the deduction 

for single taxpayers. Extending that change would 

decrease average tax rates for all couples claiming the 

standard deduction and would decrease marginal tax rates 

for some of those couples (by reducing their taxable 

income and dropping them into a lower tax bracket). 

EGTRRA also expanded the 15 percent bracket for joint 

filers to twice the size of the one for single filers. Continuing that provision would reduce both average and 

marginal rates for taxpayers whose income put them in 

the range for the larger 15 percent bracket; it would also 

reduce average, but not marginal, rates for married taxpayers in higher brackets. Finally, EGTRRA increased 

the income level at which the earned income tax credit 

(EITC) begins to phase out for joint filers. Extending 

that change would lower average tax rates for any EITC 

claimant with income above that level, as well as for some 

taxpayers who would become eligible for the EITC. It 

would also move some families out of the credit’s phaseout range, cutting their marginal tax rates, while putting 

others into that range, raising their marginal rates.

Together, those marriage-penalty provisions would have 

one of the largest effects on labor income relative to their 

cost, raising earnings in 2011 by 32 cents per dollar of tax 

change. (Only the limits on itemized deductions and personal exemptions would have a greater impact on earnings relative to their cost.) That outcome results from an 

above-average income effect combined with the biggest 

substitution effect among the provisions in this analysis. 

The above-average income effect is driven by the structure of the tax change: Because it applies only to married 

couples, it is targeted toward highly responsive secondary 

earners. In addition, two-earner married couples would 

receive larger boosts to their after-tax income, on average, 

than one-earner couples would. That distribution produces an effective income elasticity of -0.076 for those 

provisions—greater than the overall earnings-weighted 

income elasticity of -0.062 and exceeded only by the 

effective income elasticity of the child tax credit.

The substitution effect from extending EGTRRA’s 

marriage-penalty provisions would add 40 cents to earnings for each dollar in tax reduction. That high degree of 

responsiveness occurs even though 80 percent of the tax 

cut would go to taxpayers who would experience no 

change in their marginal rates. Families whose rates did 

decline, however, would see large changes—typically, a 

drop from the 28 percent tax bracket to the expanded 

15 percent bracket, increasing their after-tax wage rate by 

16 percent. Consequently, the marriage-penalty provisions would reduce marginal tax rates by almost the same 

amount per dollar of static cost as EGTRRA’s statutory 

rate reductions would. Because the cuts in marginal tax 

rates would be so targeted toward highly responsive secondary earners, the marriage-penalty provisions would 

have an effective substitution elasticity of 0.202—well 

above the economywide earnings-weighted substitution 

elasticity of 0.141. Those factors combine to produce 

the largest substitution effect (relative to cost) of any 

EGTRRA provision.

Extending the provisions for marriage-penalty relief 

would also produce the third-largest revenue offset, 

reducing the cost of the change by 8.5 percent. Although 

those provisions would have the largest impact on labor 

income per dollar of tax cut, the rate at which the additional income would be taxed would be lower than for 

many of the other provisions. Most taxpayers who would 

face a lower marginal tax rate would be in the 15 percent 

bracket, so the earnings generated by the change would 

be taxed at below-average rates. In contrast, taxpayers 

across the income distribution would see lower average 

tax rates from that change. Thus, the tax rate on the lost 

income from the income effect would exceed the tax rate 

on the additional income from the substitution effect, 

further reducing the total tax revenues from the higher 

earnings.

Tax Rates on Capital Income

In addition to accelerating some of EGTRRA’s provisions, JGTRRA lowered tax rates on capital gains and 

qualified dividends. The primary macroeconomic effect 
16 THE EFFECT OF TAX CHANGES ON LABOR SUPPLY IN CBO’S MICROSIMULATION TAX MODEL

of those reduced rates comes from their impact on investment and savings behavior, which is beyond the scope of 

this analysis. The lower rates on capital income do have 

some direct effects on the supply of labor, however. They 

alter labor income by reducing average tax rates for most 

taxpayers with dividends or capital gains. Because the 

lower rates do not apply to labor income, most taxpayers 

would see no change in their marginal tax rates on earnings if those provisions were extended. In some cases, 

though, the lower rates on capital income could interact 

with other tax provisions, reducing marginal tax rates on 

earnings for some taxpayers and raising them for others.

Extending the capital-income provisions would provoke a 

smaller labor-supply response than any other provision in 

this analysis, both in absolute terms and relative to the 

cost of the provisions. Both the income and substitution 

effects would be small, changing earnings in 2011 by less 

than 2 cents per dollar of tax reduction. The estimated 

income effect is driven by the distribution of the tax 

change. Taxpayers with no earnings (who cannot decrease 

the amount they work) would receive 27 percent of the 

tax cut, a far greater proportion than from any other provision. Moreover, among earners, a smaller share of the 

tax cut would go to secondary workers than from any 

other provision. In terms of the substitution effect, the 

lower rates on capital gains and dividends alter the marginal taxation of labor income very little, so continuing 

those rates would reduce the marginal tax rate on earnings by just 0.03 percent—the smallest change of any 

provision, in absolute or relative terms. That modest 

impact, coupled with a low substitution elasticity caused 

by the distribution of the tax cut, would produce the 

smallest substitution effect of any provision that CBO 

analyzed. 

The Labor-Supply Effects of Extending 

EGTRRA, JGTRRA, and AMT Relief, by 

Earnings Group

Extending the various tax provisions discussed above 

would have differing effects on labor supply among 

households at different income levels. Those effects 

would also vary according to the makeup of the household. CBO’s elasticity assumptions incorporate the finding that secondary earners are more responsive than primary earners to changes in after-tax wage rates and that, 

among primary earners, responsiveness varies with earnings. Together, those effects cause the labor-supply implications of the potential change in tax policy to vary across 

the earnings distribution.

The effects on marginal tax rates would be particularly 

uneven for different income groups. Among primary 

earners, those at the lowest levels of earnings would see 

little change in marginal tax rates in 2011 if the tax 

provisions were extended (see Figure 1). Many of those 

taxpayers either owe no income taxes or receive refundable credits and thus would be unaffected by the extension of the provisions. As earnings rise, the effect on marginal rates grows, with primary workers in the third decile 

of the earnings distribution seeing one of the biggest 

changes. Taxpayers in that group would experience a significant reduction in their marginal tax rates because of 

the 10 percent bracket and the refundablity of the child 

credit. Through the next four deciles, the effect on marginal rates shrinks because taxpayers in the 15 percent 

bracket would see no change in their rates if the tax provisions were extended. The effect is larger for taxpayers in 

the top three deciles because EGTRRA’s reductions in 

statutory tax rates would lower marginal rates as well. 

Taxpayers in the top 1 percent of the earnings distribution would experience the largest percentage-point 

decline in their marginal rates. Secondary earners’ marginal tax rates would fall by an average of 3.3 percentage 

points if the tax provisions were extended, 0.1 percentage 

point more than the average for primary earners.

Changes in average tax rates from those provisions’ extension would follow much the same pattern as changes in 

marginal rates. Some of the smallest changes would occur 

at the very bottom of the income scale, where many 

workers owe no taxes. The impact of the tax-policy 

change would grow as income rose through the fifth 

decile, then shrink in the sixth through eighth deciles, 

and finally widen again at the top of the earnings distribution. Secondary earners would see a bigger decline in 

their average tax rate than primary earners would: 3.5 

percentage points versus 3.1 percentage points.

In CBO’s analysis, secondary earners have much larger 

responses to the tax-policy change than primary earners 

do, despite facing roughly comparable changes in their 

tax rates (see Table 5). That result springs from CBO’s 

labor-supply assumptions: that secondary earners have a 

combined total wage elasticity of 0.40, whereas primary 

earners have an earnings-weighted total wage elasticity of 

less than 0.04. If the tax provisions were extended, secondary earners would increase their earnings by about 
THE EFFECT OF TAX CHANGES ON LABOR SUPPLY IN CBO’S MICROSIMULATION TAX MODEL 17

Figure 1.

Effects on Marginal and Average Tax Rates in 2011 from Extending EGTRRA, 

JGTRRA, and AMT Relief, by Earnings Group

(Percent) (Percent)

Source: Congressional Budget Office.

Notes: This analysis compares current law, under which the provisions of EGTRRA and JGTRRA expire as scheduled by the end of 2010, with 

an alternative in which those provisions and increases in the exemption amount for the AMT are extended. The estimates use CBO’s 

mid-level assumptions about labor-supply elasticities (shown in Table 2). Tax rates include federal and state individual income taxes 

and payroll taxes. Marginal tax rates are weighted by earnings; average tax rates are weighted by total income.

A decile is a tenth of the distribution of workers ordered by annual earnings.

EGTRRA = Economic Growth and Tax Relief Reconciliation Act of 2001; JGTRRA = Jobs and Growth Tax Relief Reconciliation Act of 

2003; AMT = alternative minimum tax. 

2.9 percent, compared with just 0.25 percent for primary 

earners overall. Because of that large response, secondary 

earners would account for about 60 percent of the total 

change in labor income from extending the tax provisions—$25.3 billion out of $41.9 billion—despite having less than 12 percent of initial earnings. 

Among primary earners, the labor-supply effects would 

vary significantly across the income distribution. Workers 

in the second through fourth deciles would have the largest total responses to the tax change, increasing their 

earnings between 0.52 percent and 1.25 percent. That 

effect occurs for two reasons: Those taxpayers would see 

relatively large changes in their marginal tax rates, and 

lower-earning workers are more responsive to changes in 

their after-tax wage rates than higher-income workers are. 

Taxpayers in the fifth through seventh deciles would alter 

their labor supply only a little, by no more than 0.2 percent, because they would experience only a small change 

in marginal tax rates. Taxpayers in the top three highest 

deciles would increase their labor supply between 

0.21 percent and 0.27 percent, while the top 1 percent 

of earners would work about 0.40 percent more. When 

weighted by earnings, the smaller percentage changes of 

high-income workers translate into larger changes in 

labor income, so high-income workers account for most 

of the increase in earnings among primary workers. As a 

whole, primary workers would boost their earnings by 

$16.6 billion in response to the tax change; of that figure, 

the top 1 percent of primary earners would account for 

more than one-quarter, and primary earners in the two 

highest deciles would account for more than half. 

0

5

10

15

20

25

30

35

40

45

50

0

5

10

15

20

25

30

35

40

45

50

Marginal Tax Rate

Under Current Law

(EGTRRA and JGTRRA expire)

Marginal Tax Rate with

EGTRRA, JGTRRA, and

AMT Relief Extended

Average Tax Rate

Under Current

Law

Average Tax Rate with

EGTRRA, JGTRRA, and

AMT Relief Extended

Primary Earners

Lowest

Decile

Second

Decile

Third

Decile

Fourth

Decile

Fifth

Decile

Sixth

Decile

Seventh

Decile

Eighth

Decile

Ninth

Decile

Highest

Decile

Top

1 Percent

Secondary

Earners
18 THE EFFECT OF TAX CHANGES ON LABOR SUPPLY IN CBO’S MICROSIMULATION TAX MODEL

Table 5.

Effects on Labor Supply in 2011 from Extending EGTRRA, JGTRRA, and

AMT Relief, by Earnings Group

Source: Congressional Budget Office.

Notes: This analysis compares current law, under which the provisions of EGTRRA and JGTRRA expire as scheduled by the end of 2010, with 

an alternative in which those provisions and increases in the exemption amount for the AMT are extended. The estimates use CBO’s 

mid-level assumptions about labor-supply elasticities (shown in Table 2). Tax rates include federal and state individual income taxes 

and payroll taxes. Marginal tax rates are weighted by earnings; average tax rates are weighted by total income.

A decile is a tenth of the distribution of workers ordered by annual earnings.

EGTRRA = Economic Growth and Tax Relief Reconciliation Act of 2001; JGTRRA = Jobs and Growth Tax Relief Reconciliation Act of 

2003; AMT = alternative minimum tax.

5.5 0.80 4.4 -0.25 0.55 41.9 100.0 100.0 

5.5 0.38 4.2 -0.14 0.25 16.6 88.5 39.6 

Lowest decile 0.7 0.34 3.1 -0.08 0.26 0.1 0.4 0.2 

Second decile 3.3 0.97 2.1 -0.10 0.87 0.8 1.3 2.0 

Third decile 8.8 1.41 2.6 -0.16 1.25 2.2 2.3 5.2 

Fourth decile 5.0 0.81 3.6 -0.30 0.52 1.4 3.4 3.2 

Fifth decile 2.3 0.31 3.6 -0.22 0.08 0.3 4.6 0.7 

Sixth decile 1.8 0.26 3.3 -0.20 0.06 0.3 6.0 0.7 

Seventh decile 4.6 0.27 3.2 -0.08 0.18 1.1 7.8 2.6 

Eighth decile 6.4 0.36 3.6 -0.09 0.27 2.1 10.2 5.0 

Ninth decile 6.0 0.32 3.9 -0.10 0.22 2.4 14.5 5.8 

Highest decile 6.3 0.35 5.5 -0.14 0.21 6.0 37.9 14.2 

Top 1 percent 10.8 0.58 7.3 -0.19 0.40 4.2 14.0 10.0 

6.0 4.00 4.8 -1.09 2.91 25.3 11.5 60.4 

Change in

Earnings

(Percent)

Income Effect

After-Tax

Share of

(Percent)

Total Change

Share of

Initial

Earnings

in Earnings

2011

Percentage

Change in Percentage

Percent

Billions of

Dollars

Change in

Income

Change in

Percentage

Earnings

Substitution Effect 

After-Tax 

Percentage

All Earners

Primary Earners

Seconday Earners

Wage Rate

Change in

Earnings