taxation, gdpWhat empirical research has examined the elasticity of taxable income against tax rates, and what did they conclude? This research can either be macroeconomic looking at aggregate statistics, but I would certainly prefer a microeconomic study that carefully controls for other relevant variables. I have a strong preference for studies from tier one journals that are highly cited.
Thank you!
Evidence of the elasticity of tax-reported income to changes in tax rates is mixed and, in general, difficult to assess - there are substantial income and substitution effects that are difficult to disentangle. The fact that reported income is a composite of several sources, as well as tax evasion etc, make the problem even more hairy.
A seminal paper is Feldstein (1995) who uses a diff-in-diff approach centered on the 1986 Tax Reform, to find an elasticity of reported income well in excess of 1, and rising steeply with reported income.
Another very important paper is Gruber & Saez (2002), who use a different identification strategy and a long micro data panel of individual tax returns. The data allow for assessing income effects, since variation is collected from several parts of the income distribution. They also have a very instructive survey of previous work in the area.
Kopczuk (2005) makes the case for institutional factors pertinent to tax system design: deductions, for instance, corrode the tax base and act as a tax shelter.
Goolsbee (2000) focuses on top earners, specifically highly-compensated CEOs. Similar to Kopczuk, he shows that top earners will use all available technology for buffering-out the effects of increases in tax rates by beating its timing, e.g. by exercising stock options. However, regular compensation schemes indexed to labor supply as we normally perceive it, is not highly responsive.
Finally, long-run evidence and policy implications are very clearly presented in Saez (2004), with a special focus on top incomes.
Hope it helps.
The idea that individuals have a (reported) income response to tax rates is perhaps most famously demonstrated by the Laffer curve, which attempts to show how total government revenue changes with tax rates, embedding the idea that rising tax rates will eventually result in decreased government income as individuals respond by earning (or reporting) less income.
Quite a bit of work has been conducted to estimate the elasticity of taxable income (ETI). The key problem here is that, by construction, most tax systems are setup so that as income increases, so does the tax rate. Thus, much care is needed in econometric analyses, otherwise one would find the spurious result that ETIs are negative.
Perhaps the best summary is provided by the Congressional Budget Office (2004) in “Recent Literature on Taxable-Income Elasticities.” Although it is getting a bit dated, we still recommend this paper to students since it is fairly accessible. The CBO paper, and papers that cite it, would be a good basis for a literature search on the subject.
A general conclusion is that the ETI is larger for higher earners while relatively low earners have a smaller response to tax rates, perhaps because their income derives largely from labor, which leaves them constrained to accept whatever tax rate they are obliged to pay. Estimated ETIs vary though, usually from about .2 to .5
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