Abstract
The empirical literature on the elasticity of taxable income (ETI) sometimes questions whether estimated values are consistent with being on the revenueincreasing section of the Laffer curve, usually in the context of a single rate tax system or for top marginal rates. This paper develops conceptual expressions for this ‘Laffer-maximum’ or revenue-maximising ETI for the multi-rate income tax systems commonly used in practice. Using the New Zealand income tax system in 2010 to illustrate its properties, the paper demonstrates that a wide range of revenue-maximising ETI values can be expected across individual taxpayers, across tax brackets and in aggregate.
Highlights
Popular discussions of tax revenues and rates are often framed in terms of the well-known Laffer curve, in which total tax revenue is related to the tax rate, within a tax system which is implicitly thought of as being linear and with a single constant marginal rate
In this case the condition under which a rate increase leads to an increase in total revenue is expressed in terms of the aggregate elasticity of taxable income (ETI) – the proportionate change in taxable income resulting from a given proportionate change in the net-of-tax rate
The present paper seeks to answer this question by first establishing, in the context of a multi-rate income tax, expressions for the elasticity of taxable income, at any income level, above which an increase in the relevant marginal tax rate produces a decrease in tax revenue
Summary
The concept of the elasticity of taxable income (ETI) has become widely used in the literature on the incentive effects of income taxation. The present paper seeks to answer this question by first establishing, in the context of a multi-rate income tax, expressions for the elasticity of taxable income, at any income level, above which an increase in the relevant marginal tax rate produces a decrease in tax revenue This elasticity, consistent with the maximum point on the Laffer curve, is referred to as the revenue-maximising elasticity of taxable income. For taxpayers in the highest bracket, and possibly for the second highest bracket, their revenue-maximising ETIs were well within the range of estimated ETIs frequently found in empirical studies across a number of countries, including NZ This conclusion is reinforced when allowance is made for the additional features introduced by the New Zealand system of family tax credits which serves to lower substantially the revenue-maximising ETIs for taxpayers in families with children across a wide range of income levels, especially in the denser part of the taxpayer income distribution
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