Decomposing Revenue Changes

This chapter shows how income changes, in response to changes in tax rates, translate into tax revenue changes for the type of multi-step income tax function used in many countries. Revenue responses at individual and aggregate levels are examined, and it is shown that for individual rate changes, it is possible to derive simple expressions for tax revenue responsiveness that capture the various behavioural and structural responses to changes to multiple tax rates and thresholds. These expressions provide a convenient method for tax policy-makers to translate alternative assumptions regarding taxable income elasticities into revenue forecasts. In addition, the decomposition is useful in contexts where revenue changes form one component of a larger economic model. It is shown that detailed empirical investigation of the elasticity of taxable income for taxpayers in different income tax brackets can be important to assess whether cuts in some marginal tax rates are likely to be revenue-enhancing.