Employment Structure and the Rise of the Modern Tax System

Abstract

This paper shows how the increase in information trails through the long-run transition from self-employment to employee-jobs explains the rise of the modern income tax system.I construct a new database which covers 100 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 four 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 exemption threshold is maximized and remains constantly high; 4) decreases in the exemption threshold are strongly associated with increases in tax collection.These findings are consistent with a model where a high employee share is a necessary condition for effective taxation and where the rise in income covered by information trails through increases in employee share drives expansion of the income tax base.To provide a causal estimate of employee share on income tax systems, I study a state-led US development program implemented in the 1950s-60s which increased the level of employee share.The identification strategy exploits within-state changes in court-litigation status which generate 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.