Employment Structure and the Rise of the Modern Tax System∗

This paper studies how the transition from self-employment to employee-jobs over the long run of development can explain growth in income tax capacity. I construct a new database which covers 90 household surveys across countries at different income levels and 140 years of historical data within the US (1870-2010). Using these data, I first establish three new stylized facts: 1) within country, the share of employees increases over the income distribution, and increases at all levels of income as a country develops; 2) the income tax exemption threshold moves down the income distribution as a country develops tracking employee growth; 3) the employee share above the income tax threshold remains high and constant at 80-85 percent. These findings are consistent with a model where a high employee share is a necessary condition for taxation and where the rise in income covered by information trails through increases in employee shares drives expansion of the income tax base. To provide a causal estimate of the impact of employee share on the exemption threshold, I study a state-led US development program implemented in the 1950s-60s which shifted up the level of employee share. The identification strategy exploits within-state changes in court-litigation status which generates quasi-experimental variation in the effective implementation date of the program. I find that the exogenous increase in employee share is associated with an expansion of the state income tax base and an increase in state income tax revenue. ∗I thank Oriana Bandiera, Tim Besley, Henrik Kleven and Emmanuel Saez for relentless support and continued counsel on this project, and Torsten Persson for detailed comments. I thank Philippe Aghion, Miguel Almunia, Alan Auerbach, Pierre Bachas, Michael Best, Anne Brockmeyer, Robin Burgess, Benjamin Faber, Francois Gerard, Hilary Hoynes, Ethan Ilzetski, Michael Keen, Camille Landais, Peter Lindert, Guy Michaels, Gerard Padro-i-Miquel, Joana Naritomi, Dina Pomeranz, Joel Slemrod, Johannes Spinnewijn, Silvana Tenreyro, John Van Reenen, Danny Yagan, Gabriel Zucman, and seminar audience and and conference participants at UC Berkeley, London School of Economics, IIES, ZEW, the 71st Annual Congress of IIPF, the 30th Annual Congress of EEA, for helpful comments. I am grateful to university librarians Paul Horsler (LSE) and Jesse Silva (UC Berkeley) for their help in locating historical US financial and employment data; Peter Lindert (UC Davis) for kindly providing me with income and occupation estimates for the US in 1870; and Jon Bakija (Williams College) for kindly providing me with access to the US historical state income tax calculator program. †Department of Economics, London School of Economics. Contact: [email protected].