Elasticity of Substitution

Men and Women at Work - Gains from Individual Taxation and the Macroeconomic Importance of Workforce Diversity

Joint income taxation of married couples imposes a high marginal tax rate for secondary earners. Moving to individual taxation encourages female labor supply and therefore alters workforce composition. This paper develops a general equilibrium model with heterogeneous agents and family labor supply to characterize the composition channel's quantitative importance. Calibrating the model to Germany, I quantify the consequences of abolishing joint taxation. To incorporate workforce diversity, I allow for imperfect substitutability of male and female labor inputs in output production, disciplined by my estimate of the elasticity of 0.7. The complementarities between men and women substantially amplify the positive output effects of the tax reform. Labor force participation of married women rises by 12.6%, and overall output increases by 6.8%. Assuming perfect substitution, output rises by half as much because there is no demand response for male labor, and men participate less.