Elasticity of corporate taxable income: evidence from Canadian corporate tax kinks

A central tax policy parameter that has recently received much attention, but about which there is substantial uncertainty, is the overall elasticity of taxable income.We provide new estimates of this elasticity which address identification problems with previous work, by exploiting a long panel of tax returns to study a series of tax reforms throughout the 1980s.This identification strategy also allows us to provide new evidence on both the income effects of tax changes on taxable income, and on variation in the elasticity of taxable income by income group.We find that the overall elasticity of taxable income is approximately 0.4; the elasticity of real income, not including tax preferences, is much lower.We also estimate small income effects on tax changes on reported income, implying that the compensated and uncompensated elasticities of taxable income are very similar.We estimate that this overall elasticity is primarily due to a very elastic response of taxable income for taxpayers who have incomes above $100,000 per year, who have an elasticity of 0.57, while for those with incomes below $100,000 per year the elasticity is less than one-third as large.Moreover, high income taxpayers who itemize are particularly responsive to taxation.We then derive optimal income tax structures using these elasticities.Our estimates suggest that the optimal system for most redistributional preferences consists of a large demogrant that is rapidly taxed away for low income taxpayers, with lower marginal rates at higher income levels.

The elasticity of taxable income: evidence and implications

Previous literature shows that income taxation significantly affects the behavior of high-income earners and business owners. However, it is still unclear how much of the response is due to changes in effort and other real economic activity, and how much is caused by tax avoidance and tax evasion. This distinction is important because it affects the welfare implications and policy recommendations. In this paper we distinguish between real responses and tax-motivated income-shifting between tax bases. We show how the explicit inclusion of income-shifting affects the welfare analysis of income taxation. In our empirical example we find that income-shifting accounts for over two thirds of the overall elasticity of taxable dividend income among Finnish business owners. The large income-shifting response significantly decreases the marginal excess burden compared to the standard model in which the overall elasticity defines the welfare loss. However, in addition to income-shifting, we find that dividend taxation significantly affects the real behavior of owners. 11.9.2014 released WP was reissued 17.9.2015

Previous literature shows that income taxation significantly affects the behavior of high-income earners and business owners. However, it is still unclear how much of the response is due to changes in effort and other real economic activity, and how much is caused by tax avoidance and tax evasion. This distinction is important because it affects the welfare implications and policy recommendations. In this paper we distinguish between real responses and tax-motivated income-shifting between tax bases. We show how the explicit inclusion of income-shifting affects the welfare analysis of income taxation. In our empirical example we find that income-shifting accounts for over two thirds of the overall elasticity of taxable dividend income among Finnish business owners. The large income-shifting response significantly decreases the marginal excess burden compared to the standard model in which the overall elasticity defines the welfare loss. However, in addition to income-shifting, we find that dividend taxation significantly affects the real behavior of owners.

The responses of taxpayers due to the changes in tax rates have attracted the curiosity of many economists. The magnitude of taxpayers’ responses is substantially considered to be very importance in the formulation of tax and transfer policy (Giertz, 2009). The fundamental analysis on how to see the respond of taxpayers due to any changes in tax rates uses elasticity of labor supply, which estimates the changes of working hours with respect to the changes in tax rates. Because people’s response to a tax change may take several forms, including a labor supply response, elasticity of labor supply must be read carefully, as pertaining only to specific circumstances. Then, the elasticity of taxable income, which was originated by Lindsey (1986), is used and introduced to overcome such restrictions.Using very rich panel data of Indonesian taxpayers from 2007 to 2010, this study generates numerous findings about the elasticity of taxable income. The extent of taxpayers’ response deeply depends on how the secular trend of income is isolated and controlled. Without income control, the elasticity of taxable income is 0.289, while using a 10-spline of log of income, the extent is 0.368. Moreover, the study also uses net income as complement of the core estimation. This study identifies that the elasticity of taxable income in Indonesia is in the range of 0.302-0.368 depending on the income definition applied. The findings confirm with most literature on this subject and closely near to what was specified by Saez, et. al (2010) as “a consensus value.” But it should be underlined that these magnitudes are just in the short run period. This also found that the short run and medium period produce varying magnitudes. The medium run period calculation generates the number of close to zero. It might be due to the existence of income shifting, as stated by Goolsbee (2000). Another argument is myopic phenomenon. As taxpayers only focus on the situation that just happen surroundings them.The difference in the effect highpoints what Slemrod (2001) said that the magnitude of reported income elasticity is not an unchanged parameter; indeed, it is subject to government policy. Moreover, the surroundings of the tax reform and after all may also have influences.

Summaries of Articles

ABSTRACTThis article aims to estimate the elasticity of taxable income (ETI), taking into account the nature of transfers and their use as a redistribution package (involving cash and in-kind transfers) to households in Brazil. Our contributions are twofold. First, we provide a simple model with balanced-budget government that reveals the role played by cash and in-kind transfers on the labour supply (and income tax revenues thereof). Next, in order to estimate ETI in the presence of cash and in-kind transfers, Brazilian population surveys (Pesquisa Nacional por Amostra de Domicílios [PNAD]) are used to explore a limited tax reform that was implemented between 1997 and 1998. This reform only affected the higher income tax bracket. Our findings suggest that in-kind (cash) transfers are positively (negatively) associated with reported taxable income and precise estimation of ETI requires estimates of both types of transfers. Last, we estimate the ETI for Brazil in the range from 0.4 to 1.3 not different from those that maximize income tax revenues.

Hourly wage rate and taxable labor income responsiveness to changes in marginal tax rates

The elasticities of taxable (ETI) and broad income (EBI) are key parameters in optimal tax and welfare analysis. To examine the large variation in estimates found in the literature, I conduct a comprehensive meta-regression analysis of elasticities that measure behavioral responses to income taxation using information from 51 different studies containing 1,420 estimates. I find that heterogeneity in reported estimates is driven by regression techniques, sample restrictions and variations across countries and time. Moreover, I provide descriptive evidence of the correlation between contextual factors and the magnitude of an elasticity estimate. Overall, the study confirms the fact that the ETI itself is endogenous to the underlying tax system. I also document that selective reporting bias is prevalent in the literature. The direction of reporting bias depends on whether or not deductions are included in the tax base.

The elasticities of taxable (ETI) and broad income (EBI) are key parameters in optimal tax and welfare analysis. To examine the large variation in estimates found in the literature, I conduct a comprehensive meta-regression analysis of elasticities that measure behavioral responses to income taxation using information from 51 different studies containing 1,420 estimates. I find that heterogeneity in reported estimates is driven by regression techniques, sample restrictions and variations across countries and time. Moreover, I provide descriptive evidence of the correlation between contextual factors and the magnitude of an elasticity estimate. Overall, the study confirms the fact that the ETI itself is endogenous to the underlying tax system. I also document that selective reporting bias is prevalent in the literature. The direction of reporting bias depends on whether or not deductions are included in the tax base.

Since Feldstein (1999), the most widely used method of calculating the excess burden of income taxation is to estimate the effect of tax rates on reported taxable income. This paper reevaluates the taxable income elasticity as a measure of excess burden when individuals can evade or avoid taxes. In many cases, part of the cost of evasion and avoidance reflects a transfer to another agent in the economy. I show that in such situations, excess burden depends on a weighted average of the taxable income and total earned income elasticities, with the weight determined by the marginal resource cost of sheltering income from taxation. This generalized formula implies that the efficiency cost of taxing high income individuals is not necessarily large despite evidence that their reported incomes are highly sensitive to tax rates.

Current reform proposals in international and corporate tax (most notably the OECD’s GloBE proposal) envisage taxing financial statement income. This paper develops a conceptual framework – based on the literature on the elasticity of taxable income – for the welfare analysis of such proposals, and discusses the available evidence on the tax elasticity of financial statement income. The central conclusion is that the most relevant evidence suggests a large responsiveness of financial statement income to taxes (and hence, albeit with significant limitations and caveats, arguably a large deadweight loss). The paper also highlights the need for more evidence on this question.

Current reform proposals in international and corporate tax (most notably the OECD’s GloBE proposal) envisage taxing financial statement income. This paper develops a conceptual framework – based on the literature on the elasticity of taxable income – for the welfare analysis of such proposals, and discusses the available evidence on the tax elasticity of financial statement income. The central conclusion is that the most relevant evidence suggests a large responsiveness of financial statement income to taxes (and hence, albeit with significant limitations and caveats, arguably a large deadweight loss). The paper also highlights the need for more evidence on this question.

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.

A key tax policy parameter that has received much attention in the international literature, but about which there is substantial uncertainty, is the overall elasticity of taxable income. The size of this parameter is central to the formulation of tax and transfer policy, as well as for the study of the welfare implications of tax decisions. This paper uses a panel of individual tax returns for the period 2009–2013 and the phenomenon of “bracket creep” to construct instrumental variable estimates of the sensitivity of income to changes in tax rates. Estimates suggest that the overall elasticity of taxable income is approximately 0.3, while that of broad income is significantly lower. The overall response is primarily driven by the elastic response of taxable income for high‐income earners, who have an elasticity of closer to 0.4. Using the elasticity estimates within an optimal tax framework, it is determined that the optimal marginal tax rate for the top 10% of income earners is broadly in line with the current income tax schedule. However, results also suggest that there is little scope for raising marginal rates on high‐income earners further without inducing a negative revenue response.