As disincentives to work, higher taxes affect women more

In 2004, Nobel Laureate and W. P. Carey Professor of Economics Ed Prescott started the debate about why Europeans, as a whole, work so much less than Americans. His answer: Europe’s higher taxes dull the incentive to work. Alex Bick, also an economics professor at the W. P. Carey School, has taken the question a step further: Could tax differences also explain differences in how much married men and women work?

First published in the W. P. Carey magazine, Fall 2016.

Research by Alex Bick, Assistant Professor of  Economics

In 2004, Nobel Laureate and W. P. Carey Professor of Economics Ed Prescott started the debate about why Europeans, as a whole, work so much less than Americans. His answer: Europe’s higher taxes dull the incentive to work. Alex Bick, also an economics professor at the W. P. Carey School, has taken the question a step further: Could tax differences also explain differences in how much married men and women work? It turns out, yes. In a recent working paper, Bick and his co-author, Nicola Fuchs-Schündeln from Goethe University Frankfurt, compare the aggregate number of hours worked by married men and married women in the United States and Europe.

For Bick, the answer begins with an understanding of differences in hours worked between Europe and the U.S. “Given what we know from Prescott’s work, it was no surprise to find that married men work less in Europe than in the U.S.,” Bick explains. “In addition, the number of hours worked by married men is fairly consistent across Europe.” The findings about married women, though, were quite different. Bick explains, “Married women in eastern Europe and Scandinavia work far more hours than married women in western and southern Europe. In fact, married women in eastern Europe and Scandinavia work only slightly fewer hours than married women in the U.S.” Why do the cross-country comparisons look so different for women and men? Clearly, there are many reasons for these differences, but, Bick says, a significant part of the answer is taxes.

Cross-country tax differences impact men and women differently

Bick’s conclusions have nothing to do with gender per se; they are about how taxes affect the work incentives of the secondary earner in a married couple. On average, married women in the U.S. and Europe work fewer hours and earn lower wages than married men, such that in the majority of married couples the woman is the secondary earner. The easiest way to understand Bick’s study is with a concrete example. Bick offers up three countries: the U.S., Germany and Sweden. In the U.S., average tax rates are low, and married couples are taxed jointly. In Germany, average tax rates are high, and married couples are taxed jointly.

In Sweden, average tax rates are high, and married couples are taxed separately. If only the husband works, and he works the average number of hours, the average income tax rate is about 33 percent in Germany and Sweden, and 21 percent in the U.S. That lines up well with the fact that married men work about the same number of hours in Germany and Sweden, and more hours in the U.S. “But if the wife works as well, the picture looks quite different,” Bick says. The average marginal tax rate on wives’ earnings, i.e. how much tax the couple has to pay on the additional income earned by the woman, is about 29 percent in the U.S. and Sweden and 50 percent in Germany. As for men, these differences are in line with the observed differences in the data: Married women work about the same number of hours in the U.S. and Sweden, and far fewer hours in Germany (34 percent fewer). The higher the taxes, the greater the disincentive to work.

In each country, the relative strength of the disincentives for married women to work depends on both the progressivity of the tax code and the tax treatment of married couples. Progressivity reflects how fast the tax rate paid on an additional dollar earned (the marginal tax rate) increases with overall level of earnings. In cases where married couples are taxed jointly, as in Germany and the U.S., the two incomes are combined and then taxed at the same marginal tax rate for that combined level of income. For most married couples in the U.S., this implies that the spouse with the higher earnings ends up in a lower tax bracket, and the spouse with the lower earnings ends up in a higher tax bracket, compared to an unmarried couple with the same earnings situation. In countries where married couples are taxed separately, as in Sweden, each spouse’s income is taxed at the rate set for that level of income, so a wife earning less than her husband would be taxed at a lower tax rate. In Sweden, the benefits of separate taxation for wives’ income actually cancel out the disincentive of the higher tax rate.

Beyond cross-country differences — why women work less than men

More than illuminating the reasons why married women in western and southern Europe work so much less than married women in eastern Europe, Scandinavia or the U.S., Bick’s research sheds light into why, on average in Europe and the U.S., married women work less than married men. Consider the earlier example: in both the U.S. and Germany, the high marginal tax rates on the secondary earner implied by joint taxation reduce the incentive to work drastically.

The opposite is also true: lowering the tax burden incentivizes work. Bick says that a third of the increase in married women’s labor force participation from the 1980s to the mid-2000s can be explained by tax reforms that decreased the marginal tax rate on secondary earners, which is historically and still today in the majority of couples the woman. Policymakers could lower married women’s tax burden by changing the progressivity of the tax code or changing the tax treatment of married couples. On the first, Bick says that progressivity affects men too, but because women are less likely to be primary earners, and more likely to not work, the progressivity of the tax code affects them more.

Sweden makes clear that progressivity alone isn’t necessarily a disincentive for married women to work, if the couple’s income is taxed separately. “So if a country like Germany wanted to increase the numbers of hours worked by married women,” Bick says, “a good policy to consider would be changing the tax treatment of married couples so that their incomes are taxed separately.” From Silicon Valley to Washington D.C., many ideas have been offered up to help women get into and thrive in the workforce. Alex Bick’s research shows that tax code reform, as unromantic as it may be, deserves its place with the best of those ideas.