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International Tax and Public Finance

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30.10.2019

Problematic response margins in the estimation of the elasticity of taxable income

verfasst von: Kristoffer Berg, Thor O. Thoresen

Erschienen in: International Tax and Public Finance | Ausgabe 3/2020

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Abstract

The elasticity of taxable income (ETI) holds the promise of representing a summary measure of tax efficiency costs, which means that further information about the behavioral components of the ETI is not required for its use in tax policy design. However, since there are response margins that can cause biases in the estimation of the elasticity, this paper warns against neglecting information about the composition of the behavior summarized by the ETI. When using responses of the Norwegian self-employed to the tax reform of 2006 for illustration, we discuss how three different response margins relate to the overall ETI: working hours, tax evasion and shifts in organizational form. We provide empirical illustrations of effects of each of these margins and argue that the standard procedure for estimating the ETI produces a biased estimate due to the organizational shift margin.

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Chetty (2009) differentiates between tax sheltering as transfers to other agents in the economy and real resource costs.

See Doerrenberg et al. (2017) on the use of the ETI as a sufficient statistic in the presence of deduction possibilities.

In the US context, after TRA 1986, one saw that taxpayers moved from Subchapter C, which includes corporate income tax on profits, toward Subchapter S, implying that profits are taxed directly at the individual level (Saez 2004).

Whereas estimates of the ETI for wage earners have been obtained for a wide selection of countries, see Auten and Carroll (1999) and Gruber and Saez (2002) for the USA, and Aarbu and Thoresen (2001), Blomquist and Selin (2010), Kleven and Schultz (2014) and Matikka (2018) for Norway, Sweden, Denmark and Finland, respectively, there are relatively few studies of the ETI for the self-employed. Exceptions include Wu (2005), Blow and Preston (2002), Heim (2010), Kleven and Schultz (2014). Note also that Saez (2010), le Maire and Scherning (2013) and Bastani and Selin (2014) estimate taxable income elasticities for the self-employed, but use bunching techniques in the identification.

Some simplified calculations based on income statistics (Statistics Norway 2014) suggest that approximately 4–5 percent (measured both at the household level and at the individual level) of total (gross) income comes from business income.

Although self-employment rates are higher in many other countries, they have been falling in most countries over time (OECD 2019).

However, Lindsey (1987) used repeated cross sections. See also Goolsbee (1999).

The latter is defined as businesses in which the active owner holds more than two-thirds of the shares.

Use 1$ = 6.42 Norwegian kroner (NOK) and 1€ = 8.05 NOK (2006-rates) to convert to US dollars and euros.

Christansen (2004) sees this as resulting from political games motivated in part by the concerns of politicians of various colors with special interest groups.

This particular schedule represents a separate opportunity for identification of response to tax changes, but, as seen in the figure, it only applies to very large incomes.

In 2000 the share of the self-employed belonging to the liberal professions was 42% (Ministry of Finance 2003).

Thus, this is a clear example of policy-makers having access to several tools for tax optimization—recall that the ETI in this perspective can be seen as controlled by the policy-makers (Slemrod and Kopczuk 2002).

Note that there is another acronym too: Goolsbee (1999) refers to studies in this field as belonging to the “New Tax Responsiveness” (NTR) literature.

Blomquist and Selin (2010) also address this problem.

An important reason for income being the preferred measure is that it reflects the overall efficiency costs of taxation, as made clear by Feldstein (1995, 1999).

There are likely mean reversion effects in work, as people have temporarily high income in the year used to measure the change in the net-of-tax rate due to the reform (in 2004), because they have high working hours. But such effects are expected to be equally present pre- and post-reform and should therefore not bias estimates.

In the seminal model of Allingham and Sandmo (1972), a tax increase has two contradicting effects on tax evasion: the return to cheating goes up, but at the same time it lowers (full compliance) post-tax income, which most likely makes people more risk averse.

See also Kuka (2014) on obtaining a tax evasion component, but with the use of bunching techniques.

Thus, reflecting that the household is the economic unit in the consumption data.

As both income and $ k $ are assumed to be stochastic according to Pissarides and Weber (1989), there are more complications involved when obtaining estimates of $ k $, discussed with respect to Norwegian data in Nygård et al. (2019).

One may employ a balanced panel of self-employed individuals for the whole time period 2001–2010 in the empirical investigation, but this would not eliminate the bias from sample selection.

See Christansen and Tuomala (2008) for a discussion of consequences of income shifting for optimal taxation.

Heim (2010) distinguishes between a real response part and an evasion part by adopting estimates of Clotfelter (1983) and Joulfaian and Rider (1998) for the latter.

Of course, one should not necessarily find similar response estimates across countries and across studies. One obvious source of variation in estimates is the size of the tax reform used in the identification of effects, as discussed by Chetty (2012). However, as the literature seems to suggest stronger responses in the USA than in the Scandinavian countries, one should take a closer look at explanations in the future. See also Kleven (2014).

Also, those with higher negative self-employment income than other types of income are included among the self-employed.

Note that the specification behind the results of column (4) also includes a mean reversion control, to control for possible heterogeneity in income developments across groups. Note also that in the preferred specification of Weber (2014), the instrument was based on 2-, 3- and 4-year lags, whereas a 1-year lag is used here.

Note that Saez et al. (2012) argue that repeated cross-sectional analysis may be preferable to panel data studies in some contexts.

We may conjecture that the reform is too small to see very strong effects by visual inspection. See also Chetty (2012) on how adjustment frictions and the size of the reform may influence elasticity estimates.

Tables 12 and 13 in the Appendix provide more information about the data used in this part of the analysis, which primarily are from the Survey of Consumer Expenditure.

Weaknesses in the empirical approach are admitted, although we do not believe them to affect results. For example, ideally, we would like to use a measure of permanent income when estimating the relation between consumption and income, as done in Nygård et al. (2019).

We use the delta method to calculate standard errors for $ k $, based on parameter estimates of $ \kappa $ and $ \mu $.

See Papini (2018) for a more thorough analysis of effects of the tax reform of 2006 on organizational shifts.

Three-year shifts allow us to estimate inverse probability weights for all years 2001–2010.

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Titel: Problematic response margins in the estimation of the elasticity of taxable income
verfasst von: Kristoffer Berg
Thor O. Thoresen
Publikationsdatum: 30.10.2019
Verlag: Springer US
Erschienen in: International Tax and Public Finance / Ausgabe 3/2020
Print ISSN: 0927-5940
Elektronische ISSN: 1573-6970
DOI: https://doi.org/10.1007/s10797-019-09576-3

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