Employment Structure and the Rise of the Modern Tax System

Abstract

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.