The Non-Equivalence of Labor Market Taxes: A Real-Effort Experiment

Under full rationality, a labor market tax levied on employers and a corresponding income tax levied on employees are equivalent. With boundedly rational agents, this equivalence is no longer obvious and the different reactions to these two taxes become important for policy making, political economics, and optimal taxation theory. In a real effort laboratory experiment, we study the differential effects of the two taxes on preferences concerning the size of the public sector, subjective well-being, labor supply, and on-the-job performance. Our findings suggest that employer-side taxes induce preferences for a larger public sector. In addition, subjective well-being is higher while labor supply is lower when the taxes are levied on employers. Furthermore, we observe gender effects. Women react strongly with respect to subjective well-being while men are mainly affected in labor supply and job performance. We discuss three mechanism that may underlie these results.