The Nordic Model - Embracing globalization and sharing risks

Prime age males do
not work much more
at lower marginal tax
rates – but the labour
supply of the young,
the old and those with
low incomes may be
significantly affected
by the average tax
rate
work?”). Both margins are important, but there is an emerging
consensus among researchers that the “extensive” margin is more
important for policy purposes.
In other words, the effect of tax and social security parameters
on the decision “shall I participate in the labour market?” is more
important than the effects on the decision “how many hours shall
I work, provided I have a job?”. The extensive margin is closely
related to the age profile of individuals as well as their net contribution
to the public sector. In terms of our figure 1.1 in chapter
1, the key policy issues become: how to encourage the inflow of
young people into the labour force and how to contain the outflow
of elderly people into retirement?
The importance of the extensive margin has only recently
been appreciated in the scholarly literature and policy debate 3 .
Traditional labour supply analysis has been mainly concerned with
the labour supply elasticity of those working, and found it to be
low. 4 The new strand of analysis, focussing on the extensive margin,
is associated with significantly higher estimates of labour supply
elasticities. This also leads to a different assessment of the role
of taxes in inhibiting the supply of market work. The traditional
textbook analysis of the choice of leisure versus work assumes that
only the marginal tax rate (not the average tax rate) affects working
hours. The new theoretical paradigm 5 , by contrast, emphasizes the
connection between average taxes and labour supply (taking also
into account the possible withdrawal of social benefits). It turns out
that the importance of the extensive margin gives rise to a much
more significant distortion in the choice between leisure and work
than most economists have hitherto assumed. These conclusions
are reinforced by recent empirical research emphasizing the large
participation response of certain subgroups of the population. In
particular, the labour supply decisions of people at the lower end
of the earnings distribution and of the young and the old (as well
as of intersections of these groups, the low-skilled old and lowskilled
young) may be influenced quite a lot by the design of tax,
social protection and pensions systems 6 .
Comparative data on participation rates suggest that a large
part of the US-Europe gap in life cycle working hours is accounted
for by different choices along the extensive margin, i.e. differences
The labour market: enough workers working enough? · 107