Overview

Abstract (English)

How important are adjustment costs for individuals when they face incentives to work induced by a policy change? I provide the first estimate of heterogeneous adjustment costs by exploiting a unique policy change that induces large incentives to work. The policy change dramatically decreased marginal tax rates on earnings in a non-linear tax schedule on earnings in a disability insurance program in Canada. Individuals continue to bunch at the location of a kink even when the kink no longer exists, suggesting that they face adjustment costs when changing their labor supply. I use the amount of bunching at the kinks before and after the policy change to estimate the size of adjustment costs that vary by individuals’ ability to work. The estimated adjustment costs are higher for individuals with lower ability; varying from zero to 8 percent of their potential earnings. The estimated elasticity of earnings with respect to tax rates – accounting for heterogeneous adjustment costs – is 0.2 which is double the size of the one estimated with no adjustment costs. The policy change also decreased the marginal tax rates far away from the kinks. I then evaluate the overall effects of the policy change on the labor supply using a Difference-in-Differences design. I find that some individuals work more and some others start working in response to the large induced incentives to work. Accounting for the adjustment costs then might explain the disparate findings on the effects of increase in incentives to work on labor supply in disability insurance programs. My findings therefore have important implications for designing policies and targeting heterogeneous groups to increase labor supply in disability insurance programs.

Abstract (French)

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