Tax information can unlock more workers and narrow income gaps, especially where labor shortages persist.
Imagine being offered extra hours at work but believing that most of the additional pay will disappear through higher taxes and lower benefits. You may decide that working more is simply not worth it, even when your actual take-home pay would rise substantially.
This is a real risk in countries with complicated tax-and-transfer systems. Workers must consider not only income tax, but also tax credits and benefits for housing, healthcare, childcare, and children. Each may change differently as earnings rise. The resulting confusion can affect decisions about how many hours to work.
In a recent study, we examined how well people in the Netherlands understand the financial rewards from working more, and whether clearer information changes their behaviour.
We asked a representative sample of around 2,000 working-age adults a simple question: if your gross monthly income increased by €100, by how much would your disposable income rise?
Answering correctly requires taking account of additional taxes as well as any reduction in tax credits and allowances. Economists summarize this information using the “effective marginal tax rate”: the share of an additional euro of earnings that is lost through higher taxes or lower benefits.
We compared respondents’ answers with estimates based on their actual income and household circumstances. Only about one in four had a broadly accurate view. Just over one-third overestimated their effective tax rate, while around 40% underestimated it.
The most consequential mistakes were concentrated among people with low incomes. Many believed that earning more would add very little to their disposable income when, in reality, the gain was considerably larger. Among respondents earning less than €2,000 per month, the perceived tax rate exceeded the actual rate by an average of 28 percentage points. Extra work therefore appeared much less rewarding than it really was.
To find out whether providing information changes beliefs and behaviors, we conducted a randomized information experiment. One group received clear information showing how much people in three broad income groups typically retained from an additional €100 of gross earnings. A control group received no such information.
Two months later, we contacted the same respondents again. The information had made their estimates more accurate, particularly among those who had initially been too pessimistic about the rewards from working more.
It also changed behaviour. People who had initially overestimated their effective tax rate increased their working time by about 1.5 hours per week, equivalent to an increase of roughly 8%. The effect was concentrated among lower-income workers and among those who said they were able to adjust their hours.
The intervention did not cause everybody to work more. Those who had initially underestimated their tax rate reduced their hours slightly, although this effect was not statistically clear. The main response came from people who had mistakenly believed that extra work would barely pay.
Our findings show that financial incentives matter only if people understand them. Governments may carefully design tax credits and benefits to encourage employment, but those incentives will have limited effects when citizens cannot see how working more would affect their disposable income. People should receive simple, accessible estimates showing how a change in their earnings or hours would affect the income they actually take home.
Clear information can therefore produce a rare double benefit. It can increase labor supply while reducing income inequality, because workers with relatively low incomes tend to overestimate the tax rate and thus increase hours most in response to information. This is particularly relevant in countries facing persistent labor shortages.
© Robert Dur, Job Harms, and Arjan Non
Robert Dur is Professor at the Erasmus School of Economics, Netherlands, and IZA@LISER Research Fellow
Job Harms is a Senior Policy Advisor at the Dutch Ministry of Finance, Netherlands
Arjan Non is Assistant Professor at the Erasmus School of Economics, Netherlands
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We recognize that World of Labour articles may prompt discussion and possibly controversy. Opinion pieces, such as the one above, capture ideas and debates concisely, and anchor them with real-world examples. Opinions stated here do not necessarily reflect those of the LISER.
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https://wol.iza.org/articles/do-workers-work-more-when-earnings-are-high by Tess M. Stafford