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Is the Taxable Income Elasticity Sufficient to Calculate Deadweight Loss? The Implications of Evasion and Avoidance

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  • Raj Chetty

Abstract

Martin Feldstein's (1999) widely used taxable income formula for deadweight loss assumes the marginal social cost of evasion and avoidance equals the tax rate. This condition is likely to be violated in practice for two reasons. First, some of the costs of evasion and avoidance are transfers to other agents. Second, some individuals overestimate the costs of evasion and avoidance. In such situations, excess burden depends on a weighted average of the taxable income and total earned income elasticities, with the weight determined by the resource cost of sheltering income from taxation. This generalized formula implies the efficiency cost of taxing high income individuals is not necessarily large despite evidence that their reported incomes are highly sensitive to marginal tax rates. (JEL H21, H24, H26)

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Bibliographic Info

Article provided by American Economic Association in its journal American Economic Journal: Economic Policy.

Volume (Year): 1 (2009)
Issue (Month): 2 (August)
Pages: 31-52

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Handle: RePEc:aea:aejpol:v:1:y:2009:i:2:p:31-52

Note: DOI: 10.1257/pol.1.2.31
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  1. Kaplow, Louis, 1990. "Optimal taxation with costly enforcement and evasion," Journal of Public Economics, Elsevier, vol. 43(2), pages 221-236, November.
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  9. Raj Chetty, 2009. "Sufficient Statistics for Welfare Analysis: A Bridge Between Structural and Reduced-Form Methods," Annual Review of Economics, Annual Reviews, vol. 1(1), pages 451-488, 05.
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