Are income and consumption taxes ever really equivalent? Evidence from a real-effort experiment with real goods

The public finance literature demonstrates the equivalence between consumption and labor-income (wage) taxes. We introduce an experimental paradigm in which individuals make real labor-leisure choices and spend their earned income on real goods. We use this paradigm to test whether a labor-income tax and an equivalent consumption tax lead to identical labor-leisure allocations. Despite controlling for subjects' work ability and inherent labor-leisure preferences and disallowing saving, subjects reduce their labor supply significantly more in response to an income tax than to an equivalent consumption tax. We discuss the economic implications of a policy shift to a consumption tax. ► We design a laboratory experiment to compare labor-leisure choices under a consumption tax and a theoretically equivalent labor-income (wage) tax. ► The consumption tax increases labor supply and decreases voluntary unemployment compared to the income tax. ► We discuss the economic implications of a policy shift to a consumption tax.