The backward hustle: An experimental investigation of tax code notches and labor supply

Abstract

The phase-in and phase-out of benefits as part of social safety nets has the potential to distort individuals’ labor supply decisions. Classical economic theory predicts a strong incentive to adjust labor supply and bunch at the discontinuities that arise within notched tax systems. However, such behavior has been difficult to observe in both survey and administrative data. In this paper, we design a laboratory experiment to explore the impact of notches on subjects’ bunching behavior within an environment where subjects receive full information about their payment schedules and can freely adjust their labor supply (number of tasks completed). While we find clear evidence of bunching under our notched payment system, many subjects still fail to bunch. We explore the role of behavioral factors such as self-control, overconfidence, and loss aversion as potential determinants of bunching behavior. Our results indicate that, within our sample, self-control and loss aversion have a positive and significant association with subjects’ decision to bunch, while overconfidence has a negative association. These estimates are of the expected sign and suggest that behavioral factors may serve as important underlying determinants of an individual’s decision to bunch.