Marginal tax rates must be higher in Europe. 2. Labor supply must slope upward enough to match the differences in hours.
Marginal tax rates are indeed lower in the United States than in Europe. Recent research finds that the marginal tax rate on labor income is about 34.5 percent in the United States compared to 57.7 percent in Europe (Germany, France, Italy, and the United Kingdom). So, if you work an extra hour and earn a pretax wage of $10, then you would keep $6.55 in the United States and $4.23 in Europe. The evidence is also consistent with the view that labor supply increases as the after-tax real wage increases. shows the implication of this. On the vertical axis are two different levels of the after-tax real wage: a low one for Europe and a higher one for the United States. These differences in the after-tax real wage translate into differences in hours, using the labor supply curve of an individual. Thus, as in , individuals in the United States work more hours than in Europe. As this is true for everyone in the labor force, this argument immediately translates into a statement about hours worked for the aggregate economy. Differences in Hours Supplied There are two real wages after taxes shown: one for Europe and one for the United States. These differences in real wages translate into differences in hours worked. Can the difference in the after-tax real wage explain the observed difference in hours worked? This depends on how responsive labor supply is to changes in the real wage.shows two labor supply curves. In one case (the solid curve), labor supply is very responsive to changes in the wage. Relatively small differences in taxes then have substantial effects on hours worked. In the other case (the dashed curve), labor supply is not very responsive to the wage. Differences in tax rates are then unlikely to be able to explain the differences in hours worked.
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