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Income effects and the elasticity of taxable income

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  • John Creedy
  • Norman Gemmell
  • Josh Teng

Abstract

This paper examines income effects in regression estimates of the elasticity of taxable income (ETI). One previous approach involves the proportional change in the average net-of-tax rate. It is shown that this specification can be derived from a direct utility function. Alternatively, income effects have been examined using the proportional change in virtual income. Estimation of the ETI must deal with endogeneity because observed marginal tax rates and taxable incomes are jointly determined. This paper suggests that where data are available to allow ‘no reform’ income dynamics to be estimated, they can be used to obtain the required counterfactual change in taxable income. This enables OLS to be used with an exogenous counterfactual ‘expected (marginal) tax rate’ proxy. The two specifications were estimated for New Zealand, and suggest that income effects are, at most, relatively small. They are statistically significant, and negative, only when using the change in virtual income. Importantly, the size of the ETI (which varies when income effects are present) is different depending on the specification used.

Suggested Citation

  • John Creedy & Norman Gemmell & Josh Teng, 2018. "Income effects and the elasticity of taxable income," New Zealand Economic Papers, Taylor & Francis Journals, vol. 52(2), pages 185-203, May.
    • Handle: RePEc:taf:nzecpp:v:52:y:2018:i:2:p:185-203
    DOI: 10.1080/00779954.2017.1293140
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    Cited by:

    1. Carina Neisser, 2021. "The Elasticity of Taxable Income: A Meta-Regression Analysis [The top 1% in international and historical perspective]," The Economic Journal, Royal Economic Society, vol. 131(640), pages 3365-3391.
    2. Nazila Alinaghi & John Creedy & Norman Gemmell, 2023. "Do couples bunch more? Evidence from partnered and single taxpayers," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 30(4), pages 1137-1184, August.
    3. John Creedy & Norman Gemmell, 2020. "The elasticity of taxable income of individuals in couples," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 27(4), pages 931-950, August.

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