Labor Supply, Endogenous Wage Dynamics and Tax policy

In this paper we analyze analytically, quantitatively, and empirically a framework where labor supply has three distinct roles. First, as usual, it increases contemporaneous earnings. Second, because of incomplete asset markets, it provides some partial insurance for idiosyncratic labor productivity shocks. And last, labor supply also works as investment in future earnings potential (human capital). In this sense, in our model, wage dynamics is partially endogenous. We show that, in this environment, the usual estimate of the Frisch elasticity is biased and changing the progressivity of the tax system can have much stronger impact.