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Regression Estimates of the Elasticity of Taxable Income and the Choice of Instrument

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  • Carey, Simon
  • Creedy, John
  • Gemmell, Norman
  • Teng, Josh

Abstract

This paper examines estimation of the elasticity of taxable income using instrumental variable regression methods. It is argued that the ‘standard instrument’ for the net-of-tax rate − the rate that would be applicable post-reform but with unchanged income levels − is unsatisfactory in contexts where there are substantial exogenous changes in taxable income. Two alternative tax rate instruments are proposed, using estimates of the dynamics of taxable income for a panel of taxpayers over a period that involves no tax changes. The parameters derived from this procedure are then used to construct hypothetical (or counterfactual) post-reform incomes that would be expected in the absence of reform. The first method is based on the tax rate each individual would face if income were equal to ‘expected income’, conditional on income in two periods before the tax change. The second alternative uses the form of the conditional distribution of income for each taxpayer to obtain an instrument based on the ‘expected tax rate’. The methods are applied to the tax change in New Zealand in 2001.

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File URL: http://researcharchive.vuw.ac.nz/handle/10063/2429
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Bibliographic Info

Paper provided by Victoria University of Wellington, Chair in Public Finance in its series Working Paper Series with number 2429.

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Date of creation: 2012
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Handle: RePEc:vuw:vuwcpf:2429

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Postal: School of Accounting & Commercial Law, Victoria University of Wellington, PO Box 600, Wellington, New Zealand
Phone: +64 (4) 463 5775
Fax: +64 (4) 463 5076
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Web page: http://www.victoria.ac.nz/sacl/about/chair-in-public-finance
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Keywords: Elasticity of taxable income; Variable regression methods; Tax rate instrument;

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  1. Peter Diamond & Emmanuel Saez, 2011. "The Case for a Progressive Tax: From Basic Research to Policy Recommendations," Journal of Economic Perspectives, American Economic Association, vol. 25(4), pages 165-90, Fall.
  2. Iris Claus & John Creedy & Josh Teng, 2010. "The Elasticity of Taxable Income in New Zealand," CAMA Working Papers 2010-21, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
  3. Bradley T. Heim, 2009. "The effect of recent tax changes on taxable income: Evidence from a new panel of tax returns," Journal of Policy Analysis and Management, John Wiley & Sons, Ltd., vol. 28(1), pages 147-163.
  4. Emmanuel Saez & Joel B. Slemrod & Seth H. Giertz, 2009. "The Elasticity of Taxable Income with Respect to Marginal Tax Rates: A Critical Review," NBER Working Papers 15012, National Bureau of Economic Research, Inc.
  5. Feldstein, Martin, 1995. "The Effect of Marginal Tax Rates on Taxable Income: A Panel Study of the 1986 Tax Reform Act," Journal of Political Economy, University of Chicago Press, vol. 103(3), pages 551-72, June.
  6. Seth H. Giertz, 2010. "The Elasticity of Taxable Income during the 1990s: New Estimates and Sensitivity Analyses," Southern Economic Journal, Southern Economic Association, vol. 77(2), pages 406-433, October.
  7. repec:taf:regstd:v:46:y:2012:i:2:p:159-167 is not listed on IDEAS
  8. Wojciech Kopczuk, 2004. "Tax bases, tax rates and the elasticity of reported income," Discussion Papers 0304-15, Columbia University, Department of Economics.
  9. Hansson, Åsa, 2004. "Taxpayers Responsiveness to Tax Rate Changes and Implications for the Cost of Taxation," Working Papers 2004:5, Lund University, Department of Economics.
  10. Gruber, Jon & Saez, Emmanuel, 2002. "The elasticity of taxable income: evidence and implications," Journal of Public Economics, Elsevier, vol. 84(1), pages 1-32, April.
  11. Austan Goolsbee, 1999. "Evidence on the High-Income Laffer Curve from Six Decades of Tax Reform," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 30(2), pages 1-64.
  12. Robert A Moffitt & Mark Wilhelm, 2000. "Taxation and the Labor Supply - Decisions of the Affluent," Economics Working Paper Archive 414, The Johns Hopkins University,Department of Economics.
  13. Koen Caminada & Kees Goudswaard, 1996. "Progression and revenue effects of income tax reform," International Tax and Public Finance, Springer, vol. 3(1), pages 57-66, January.
  14. Emmanuel Saez, 1999. "The Effect of Marginal Tax Rates on Income: A Panel Study of 'Bracket Creep'," NBER Working Papers 7367, National Bureau of Economic Research, Inc.
  15. Blomquist, Sören & Selin, Håkan, 2010. "Hourly wage rate and taxable labor income responsiveness to changes in marginal tax rates," Journal of Public Economics, Elsevier, vol. 94(11-12), pages 878-889, December.
  16. Austan Goolsbee, 1997. "What Happens When You Tax the Rich? Evidence from Executive Compensation," NBER Working Papers 6333, National Bureau of Economic Research, Inc.
  17. Aarbu, Karl O. & Thoresen, Thor O., 2001. "Income Responses to Tax Changes--Evidence from the Norwegian Tax Reform," National Tax Journal, National Tax Association, vol. 54(n. 2), pages 319-38, June.
  18. Giertz, Seth, 2004. "Recent Literature on Taxable-Income Elasticities," MPRA Paper 16159, University Library of Munich, Germany.
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