Transcript The Elasticity of Taxable Income with respect to Marginal

M1 PPD – 02.11.2010
Marianne Tenand
The Elasticity of Taxable Income
with respect to Marginal Tax
Rates : A Critical Review
E. Saez
J. B. Slemrod
S. H. Giertz
NBER 15012, 2009
1
Why do we want to capture this elasticity?
* Fiscal policy applications :
- Deriving the optimal size of the public sector
- Quantifying efficiency costs of a form of taxation
- Deriving the optimal tax rate(s) [t* = 1/ (1+ε) for PIT]
Make an empirical evaluation of the
Equity/Efficiency Trade-Off in income taxation
* Trade-off : results from the impossibility to tax an
intrinsic characteristic of individuals
=> Behavorial reactions => deadweight loss for
society (a priori)
2
Capturing labor supply elasticity : the quest for
the Graal
• Empirical studies and strategies to find ε
- The 1st attempts : questionnaires (Fields and Stanbury, 1969, on
lawyers)
- Guaranteed Income experiments (USA, Canada)
- Taxpayers drain (participation constraint – for richer and poorer taxpayers =>
the elasticity of labor supply of these groups is probably higher than mediumclasses’ elasticities)
- Other econometrics studies.
• Conclusion : small ec and small η => small ε
=> little efficiency costs of taxing income…?
• NOT SO FAST! Troubling evidence that taxpayers react to tax
changes! And in many other ways that just through the number of
hours worked.
The revolution of the ETI approach
• In reality : income subject to the PIT is not simply
equal to w.L => more relevant concept: reported
income, denoted z
- Z includes nbr of hours worked, effort, other forms of income, investment in
formation, propensity to report income (evasion), to use tax optimization
schemes, etc.
- Takes implicitly account of other, unobservable characteristics of income and
tax system
• Model :
Max u(c,z) where c = (1-τ)z + E
- Gives an individual « reported income » supply function
z = z(1-τ, E) where E is an income not subject to taxation
- No income effect (two channels : E and w). Then :
ETI = (1-τ)/z . dz/d(1-τ)
ETI : empirical strategies
• Focus : the upper end of income distribution
- Let z+ be the reported income threshold above which
taxpayers face a marginal tax rate of τ
- Let zm the average income reported by taxpayers in this top
bracket.
zm = zm (1-τ)
- The aggregate ETI in the top bracket is
e = (1-τ)/zm . dzm /d(1-τ)
= average of individual elasticities weighted by individual
income.
Then : reported income zi,t = z0i,t .(1 –τi,t )e
individual i, time
t.
Where z0i,t is the potential income ( reported if τi,t = 0)
- Important assumptions : no income effects/ short-term and long-term –
responses are identical/ constant e over time / perfect information
Identifications issues
Log zi,t = e. log (1 - τi,t ) + log z0i,t
* OLS : endogeneity problem since log z0i,t (the unobservable),
is (positively) correlated with τi,t
Solution : find instruments correlated with τi,t but
uncorrelated with potential reported income z0i,t
* Instruments at our reach : changes in tax rates provoked by
tax reforms (natural experiments) or unlesgislated changes.
* Where/ when ? USA (mainly) and other developed countries ;
exploiting the major tax shifts experienced since the 1970s.
Simple before and
after reform
comparison
-2SLS with postreform dummy as
instrument for log(1τi,t )
- comparing z before
and after the reform :
Δz is attributed to
Δ(1-τ)
-But what about secular
growth? business cycles?
= Problem of correlation of
income with time
- Identification
condition : log-potential
incomes are not
correlated with time
- Usually tax reforms affect
groups of population in
different ways : comparing the
changes for these groups?
=> other methods possible
- Identification
condition : parallel
evolution of the two
groups, absent the
reform
- Different ways of
implementing this strategy
= idea of the
strategies : comparing
changes among
different groups
* DD analysis
* Share analysis…
Share analysis
- Extension : full-time
-Δshare of total income
reported by the top percentile series (using a time-series
Idea = To control
for macro growth,
we can normalize
incomes of the
group affected by
a tax change by
the average
income in the
population (if the
group is small)
regression to incorporate
- identification condition : the more years)
Graph : evolution of
the share of top
reported income
share of the treatment group
changes significantly at the
time of the change in his
marginal rate while the share
of the control group is
uncorrelated with the
evolution of this marginal
rate.
Pt is the share accruing to the
top 1% earners in year t.
-Concern : e is unbiased if
income inequalities would
have remained the same
(or evoluted randomly)
absent the tax reform
-=> strong evidence that
this hypothesis is
violated! (blue arrows)
-The estimate of e is
upaward-biased…
- finding controls = a
challenge…
Sensitivi
ty to the
specific
reform
and to
the
choice
of the
years
Timeserie
identifi
cation
at risk
Different
elasticities
for differing
groups?
Endogeneity
?
Upward bias
Repeated
Cross-Section
Analysis
2SLS- Instrument for 1-τi,t : the postreform and treatment group
interaction 1(t=1). 1(i € T)
Idea : use a tax
reform that
affected the
marginal tax rate
of the top 1% (Tgroup) and that
didn’t affect the
next 9% (Cgroup)
-Estimate of e = ratio of the pre to
post reform change in (log) incomes
in the T group minus the same ratio
for the C group, to the same DD in
the (log) net-of-tax rates
-identification conditions :
*the composition of the two groups
should not change in a systematic
way
* the ETI is the same for T and C
groups
Ex : 1993 reform
(new brackets
with higher rates
at the top) (green - estimate is unbiased if the parallel
trend assumption holds
arrows)
-parallel trend assumption is
violated (test on pre and post
reform)
-Solution : running the 2SLS on
several pre- and post-reforms
years, adding time trends as
controls
(implicit hyp : short-term and
long-term, transitory and
permanent ETI are the same)
- ETI seems to vary accross
groups!
Panel Analysis
Idea : use a tax
reform that
affected the
marginal tax
rate of the top
1% (T-group)
and that didn’t
affect the next
9% (C-group.
The income
groups are
defined
according to
pre-reform (t0)
income, and
are followed in
the post-reform
year (t1)
- Control for non-tax related change in
inequalities
-Estimate of e = very
similar to the
estimate obtained by -Mean reversion (transitory incomes)= a big
cross-section.
issue => the estimate is very sensitive to the
lag between t1 and t0 and the group chosen
-Unbiased if, absent as control.
the reform, the (log)
income changes are - controls for mean-reversion bias and nonthe same for the T
tax related change in income distribution =
and C groups
can destroy identification if only 2 years
(beware, this
assumption mixes
- to avoid this sensitivity to the base-year
together changes in income, we can add controls and compare
income inequalities
several years (identification : absent the tax
and individual
change, year-to-year mean reversion and
income mobility)
income inequalities change are stable over
the period)
Not
sensitive to
the choice
of the base
group
Mean
reversion =
upward bias
with a rate
increase
(even larger
for 49% Cgroup ; and
when lag
increases)
Lacks
controls
(parallel
trends
violated)
Pb of
identifica
tion
More
satisfactory
estimates ;
even if…
• Conclusions :
- share analysis and cross-section analysis seem more robust to
estimate the ETI
- But panel analysis may be really performing in specific
circumstances (ex: 1993)
« The most reliable long-run estimates range from 0.12 to 0.4,
suggesting that the US marginal top rate is far from the top of the
Laffer curve, but greater that one would calculate if the sole
behavorial response was labor supply. Estimates for other
[developed] countries are, for the most part, in this range. »
 The fear - expressed in the 1980s with the Conservative
revolution- that in most developed countries marginal tax rates
were sub-optimally high, was exaggerated…
- But nonetheless, several issues still need to be tackled…
Further issues (and work for you!)
The studies are still unsatisfactory under certain aspects :
- short term vs long term responses
- small changes vs large changes in tax rate (question of the perfect
information of taxpayer and of transaction costs)
- tax base shifting (application : welfare analysis and change in the
revenue-maximizing tax rate). The authors call for examining closely
the “anatomy of response [to tax]”, to distinguish between the
many effects incorporated in z.
- Constance of elasticities across time? Across countries?
(hypothesis of Kopczuck that e is not a structural parameter, but a
function of the income base)
=> In matter of empirical studies on behavioral reaction to
taxation, much is still to be done!
References and remarks
More to be found in this article
- A bunch of empirical studies (developed countries, other than the USA) are
reviewed in the article
- Interesting explanations about fiscal externalities and their consequences
on effective efficiency costs (particularly on tax base shifting : to set optimal
tax rates, you must take into account the various existing taxes and their
inter-relations)
- In Annexes, details about US databases and tax reforms.
Other texts
-
Fields, DB and W.T. Standbury. 1971. Income Taxes and Incentives to work : some
additional empirical evidence, AER
Kopczuk, Wojciech. 2005. Tax Bases, Tax Rates and the Elasticity of Reported
Income. Journal of Public Economics
Saez, Emmanuel. 2001. Using Elasticities to Derive Optimal Income Tax Rates.
Review of Economic Studies, 68: 205-229.
Several works of Joel Slemrod, Martin Feldstein, Peter Diamond and James
Mirrless.