Working today vs. working tomorrow: Estimating the Intertemporal Elasticity of Substitution using time notches
This paper develops a new framework to estimate the Frisch elasticity using time notches – a discrete jump in tax liability at a cutoff date. Time notches provide large incentives to shift labor supply from a period after the cutoff date to a period just before the cutoff date. I develop a dynamic bunching approach that links the behavioral response of workers to the underlying Frisch elasticity. I apply this framework to the study of an unusual anticipated tax change. In many countries, job seekers must meet requirements for wages earned or hours worked to claim unemployment benefits. These requirements must be fulfilled in a given period of time referred to as a “base period”. The “base period” defines the period over which labor supply contributes to future unemployment benefits. The time notch generated by the anticipated end of the “base period” introduces a discrete jump in the effective tax rate (the nominal tax rate minus the marginal unemployment benefit rate). Using rich administrative data on French arts workers, I find clear evidence of bunching around the time notch and estimate a Frisch elasticity of 1.