Abstract
We study how taxable income responds to changes in marginal tax rates, using as a main source of identifying variation three large reforms to the Spanish personal income tax implemented in the period 1999–2014. The most reliable estimates of the elasticity of taxable income (ETI) with respect to the net-of-tax rate for this period are between 0.45 and 0.64. The ETI is about three times larger for self-employed taxpayers than for employees and larger for business income than for labor and capital income. The elasticity of broad income is smaller, between 0.10 and 0.24, while the elasticity of some tax deductions such as the one for private pension contributions exceeds one. Our estimates are similar across a variety of estimation methods and sample restrictions and also robust to potential biases created by mean reversion and heterogeneous income trends.
Highlights
The impact of personal income taxes on the economic decisions of individuals is a key empirical question with important implications for the optimal design of tax policy
We study how taxable income responds to changes in marginal tax rates, using as a main source of identifying variation three large reforms to the Spanish personal income tax implemented in the period 1999–2014
We first present our main estimates of the elasticity of taxable income for the period 1999–2014, using the longest panel dataset available in a consistent format
Summary
The impact of personal income taxes on the economic decisions of individuals is a key empirical question with important implications for the optimal design of tax policy. Reported taxable income reflects individuals’ decisions on hours worked, and work effort and career choices as well as the results of investment and entrepreneurship activities. Besides these real responses, the ETI captures tax evasion and avoidance decisions of individuals to reduce their tax bill. The 2007 reform was an overhaul of the income tax system, turning the standard personal deduction into a tax credit, which increased the progressivity of the tax It modified the definition of tax bases, shifting a substantial part of capital income from the “general” to the “savings” tax base and thereby lowering the marginal rate on capital income. The 2012 reform, introduced in the middle of a severe recession, increased tax rates across the board, pushing the top marginal rate up to 52% (further increased to 56% in some regions, like Andalusia and Catalonia)
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