All Income is Not Created Equal: Cross-Tax Elasticity Estimates in the United States

Abstract

In the United States, marginal tax rates on capital income and ordinary income (e.g. wages and salaries) can vary substantially. The same household might face a federal tax rate on their wage income that is 20 percentage points higher than the tax rate on long-term capital gains. This differential complicates welfare and revenue analyses of tax reforms, as individuals might alter their capital income decisions in response to an ordinary income tax change. In this paper, I estimate cross-tax elasticities for capital and ordinary income, using a large non-public panel of federal income tax returns from 1997-2007. I find two key results, though both are sensitive to a variety of specification decisions. First, capital gains respond to both the capital gains tax rate and the ordinary income tax rate. Second, I find mixed evidence that ordinary income responds to the ordinary income tax rate and the long-term capital gains tax rate. These results suggest cross-tax responses between these two bases are important, and should not be ignored when estimating taxpayer responses in the United States.