Will individual income tax cut increase labor supply?

YE Jingjing1 WU Yan1 CHEN Fanghao1 WANG Yuqing1

(1.Research Institute of Economics and Management, Southwest University of Finance and Economics )
【Knowledge Link】fixed effect model

【Abstract】According to Decree NO. 600 of the State Council of the People’s Republic of China, China raised the threshold of individual income tax and reduced the tax tiers in September 1, 2011. This paper focuses on evaluating the impact of the implementation of the Law on the individual labor supply and further explores the role on the income distribution gap. Using the Chinese Household Finance Survey (CHFS) 2011–2013 panel data, we apply the difference-in-difference method and fixed effect model, and take reference to the regression discontinuity design. We find that this individual tax reform improves the individual labor force participation, but has insignificant effect on the labor hours. Especially, the labor incentive of high income groups is higher than that of low income groups. Therefore, the income tax cut will improve China’s overall labor supply, but not help to reduce the residential income gap.

【Keywords】 individual income tax reform ; labor supply; difference-in-difference method; fixed effect model;


【Funds】 Youth Project of National Natural Science Foundation of China (71403220) Special Fund for Basic Scientific Research Fund for the Central Universities (JBK170955)

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(Translated by YUE Cuiping)


    [1]. ① As for details of the Act, please refer to http://www.gov.cn/gong-bao/content/2011/content_1918912.htm [^Back]

    [2]. ② Section 2 of this paper gives a detailed introduction to the evolution of individual income tax system in China over the years. [^Back]

    [3]. ③ In the next section, Figure 2 shows the distribution of the monthly income of the sample in 2011. [^Back]

    [4]. ④ The effects of the factors that do not change with time or have the same changes, such as gender and age, are eliminated in the FE estimate and are therefore not included. [^Back]

    [5]. ⑤ Referring to Eissa and Liebman (1996), when we estimate the impact of tax reform on labor hour, we only use samples of working before and after the tax reform. The reason for this process is as following: The classic method used to solve the sample selection problem in the previous literature is the Heckman binary sample selection model, However, the Heckman binary sample selection model has two basic assumptions. The first one requires the random disturbance term to obey the normal distribution, and the second one is to find an exogenous variable that is related to the employment decision equation and has nothing to do with the working hour equation. But we cannot verify whether the random disturbance term is subject to a normal distribution. Since employment decisions have a strong correlation with working hours, it is difficult to find a reliable exogenous variable that is only related to the employment decision equation, so the Heckman binary sample selection model lacks reliability. Therefore, the Heckman binary sample selection model lacks reliability. To this end, we only use samples that work before and after the tax reform to avoid the risk of estimation errors caused by Heckman’s setting errors. [^Back]

    [6]. ⑥ We also select samples with CNY 700 and CNY 1000 income intervals on both sides of the tax rate boundary, and the results are also significant. In the robustness test, we give the analysis results of the income range of CNY 1000 on both sides of the tax rate boundary, which are shown in Table 10. [^Back]


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This Article


CN: 11-1235/F

Vol , No. 12, Pages 20-32+187

December 2017


Article Outline



  • 1 Introduction
  • 2 Background and literature review
  • 3 Theoretical framework
  • 4 Empirical analysis
  • 5 Data and descriptive statistics
  • 6 Empirical results
  • 7 Conclusions and policy recommendations
  • Footnote