Does the Marginal Tax Rate Affect Activity in the Informal Sector?

Research report

May 2014


Externally reviewed

Study Paper No. 64


Written by: Peer Ebbesen Skov and Søren Leth-Petersen


Tax and undeclared work are indissolubly linked, since without taxation they would be no such thing as non-declaration. But how much do Danes change their supply of undeclared labour as a result of changes in the level of tax on income? The tax reform of 2010 reduced the highest marginal tax rate payable from 63 percent to 56 percent, while at the same time the highest tax threshold was raised from DKK 377,000 in 2009 to DKK 424,000 in 2010. This meant that a number of people formerly paying the highest rate of tax ceased to do so. For this group, the marginal rate of tax, i.e. the tax paid on the last krone earned, fell from 63 percent in 2009 to 41 percent in 2010. In this study paper we examine how this reduction in marginal tax rate affected the supply of undeclared labour. We then go on to analyse the effect of the ‘Home work scheme’, which made it possible from mid-2010 onward to obtain a tax deduction for salary costs involved in repairs, maintenance and cleaning of primary private homes. This meant that the cost of purchasing work in the formal economy in these sectors was reduced, so that the financial benefit from paying for such work to be done in the undeclared sector became correspondingly less. The analyses were based on interview data collected each autumn during the period 2009-12, with the same respondents being interviewed each year about their undeclared labour supply.