Camille Landais London School of Economics Lecture Notes...

download Camille Landais London School of Economics Lecture Notes ...darp.lse.ac.uk/pdf/EC426/EC426_17_13.pdf¢ 

of 37

  • date post

    01-Jan-2020
  • Category

    Documents

  • view

    5
  • download

    0

Embed Size (px)

Transcript of Camille Landais London School of Economics Lecture Notes...

  • TAXABLE INCOME RESPONSES

    Camille Landais

    London School of Economics

    Lecture Notes for MSc Public Economics (EC426)

  • AGENDA

    The Elasticity of Taxable Income (ETI): concept and policy relevance.

    The long-run evolution of top marginal tax rates and top income shares.

    Estimating the ETI: empirical strategies, identification problems, and

    findings.

    The high-income Laffer curve.

  • MOVING BEYOND LABOR SUPPLY

    A large literature estimates the elasticity of labor supply.

    Estimated labor supply elasticities are close to zero, which suggests that

    the efficiency cost of taxation is very small.

    But there are many other dimensions of behavioral response, which

    might create efficiency losses.

    A shift in focus from labor supply responses to taxable income re-

    sponses, which capture the full range of responses to taxation.

  • CHANNELS OF TAXABLE INCOME RESPONSE

    (1) Quantitative labor supply responses: hours worked, participation.

    (2) Qualitative labor supply responses: effort on the job, type of job, training, education.

    (3) Changes in savings and portfolio choice.

    (4) Legal shifting of income into untaxed or lower-taxed form [tax avoidance].

    (5) Illegal under-reporting of income [tax evasion].

  • ELASTICITY OF TAXABLE INCOME (ETI)

    Feldstein (1995, 1999) first pointed out the potential importance of the

    ETI: he argued that the ETI provides a sufficient statistic for revenue

    effects, deadweight loss, and optimal taxation.

    Joel Slemrod (1998): "recently . . . much attention has been focused on

    an elasticity that arguably is more important than all others, because

    it summarizes all of what needs to be known for many of the central

    normative questions of taxation. This is the elasticity of taxable income

    with respect to the tax rate."

    Is the ETI really that important?

  • ETI AND DEADWEIGHT LOSS

    The deadweight loss is given by = − , where is the utility loss from taxation (in monetary units) and is collected tax revenue.

    The marginal DWL is given by = − .

    We have = + where is themechanical revenue effect and is the behavioral revenue effect. We have = using the envelope theorem.

    ⇒ = − ( + ) = − .

    ⇒ marginal DWL equals behavioral revenue loss, which is determined by tax base elasticities (ETI in the context of income taxation).

  • REAL RESPONSES VS. AVOIDANCE/EVASION

    Model makes sense for real responses, but what about avoidance/evasion?

    Key assumption: fiscal externality arising from the tax wedge is the

    only externality from taxable income responses.

    This requires that the private costs of avoidance/evasion equal the social

    costs. This is not satisfied for e.g. fines for evasion, but may be for real

    tax sheltering costs and moral costs.

    Fully including evasion/avoidance in DWL calculations may overstate

    efficiency effects→ estimate both real income elasticities and ETIs.

  • ETI LITERATURE

    Lindsey (1987) andFeldstein (1995) were first to estimate the ETI, using

    the Reagan 81-reform (Lindsey) and Reagan 86-reform (Feldstein) as

    natural experiments.

    Since then, a large literature has estimated the ETI using US data.

    More recently, there has been work on other countries.

    Excellent surveys and critical discussions of the ETI literature:

    Slemrod (1998), National Tax Journal.

    Saez (2004), Tax Policy and the Economy.

    Saez, Slemrod, & Giertz (2012), Journal of Economic Literature.

  • A CENTURY OF U.S. INCOME TAXATION

    US income tax starts in 1913. Marginal tax rates (MTRs) are very low

    initially, but increase sharply in the interwar period. Large exemption

    levels implied that less than 10% of the population paid income tax.

    After 1942, exemption levels were lowered and more people included in

    the tax net. Top MTR was extremely high (94% in 1944-45).

    Since then, the top MTR has been changed as follows: 91% to 70% 1963-65 Kennedy: RA64 70% to 50% 1980-82 Reagan: ERTA81 50% to 28% 1986-88 Reagan: TRA86 28% to 31% 1990-1991 Bush Sr: OBRA90 31% to 39.6% 1992-1993 Clinton: OBRA93 39.6% to 35% 2000-2003 Bush Jr: EGTRRA01

  • TOP INCOME SHARE ANALYSIS

    Denote by the top income share and by the top MTR at time .

    If a legislated change in occurs between time 0 and 1, the ETI can

    be estimated as

    ˆ = ln 1 − ln 0

    ln(1− 1)− ln(1− 0)

    Identifying assumption: absent the tax change, the top income share would have remained constant.

    This is a dif-in-dif using the whole population as a control group: ∆ ln = %-change in top income − %-change in population income.

  • 6%

    8%

    10%

    12%

    14%

    16%

    18%

    20%

    30%

    40%

    50%

    60%

    To p

    1% In

    co m

    e Sh

    ar e

    p 1%

    M ar

    gi na

    l T ax

    R at

    e TOP 1% INCOME SHARE AND MARGINAL TAX RATE IN THE US

    Source: Saez, Slemrod, and Giertz (2009)

    0%

    2%

    4%

    6%

    8%

    10%

    12%

    14%

    16%

    18%

    0%

    10%

    20%

    30%

    40%

    50%

    60% 19

    60

    19 62

    19 64

    19 66

    19 68

    19 70

    19 72

    19 74

    19 76

    19 78

    19 80

    19 82

    19 84

    19 86

    19 88

    19 90

    19 92

    19 94

    19 96

    19 98

    20 00

    20 02

    20 04

    20 06

    To p

    1% In

    co m

    e Sh

    ar e

    To p

    1% M

    ar gi

    na l T

    ax R

    at e

    TOP 1% INCOME SHARE AND MARGINAL TAX RATE IN THE US

    Top 1% Marginal Tax Rate Top 1% Income Share

  • 10%

    15%

    20%

    25%

    30%

    20%

    30%

    40%

    50%

    60%

    N ex

    t 9 %

    In co

    m e

    Sh ar

    e

    xt 9

    % M

    ar gi

    na l T

    ax R

    at e

    NEXT 9% INCOME SHARE AND MARGINAL TAX RATE IN THE US

    Source: Saez, Slemrod, and Giertz (2009)

    0%

    5%

    10%

    15%

    20%

    25%

    30%

    0%

    10%

    20%

    30%

    40%

    50%

    60% 19

    60

    19 62

    19 64

    19 66

    19 68

    19 70

    19 72

    19 74

    19 76

    19 78

    19 80

    19 82

    19 84

    19 86

    19 88

    19 90

    19 92

    19 94

    19 96

    19 98

    20 00

    20 02

    20 04

    20 06

    N ex

    t 9 %

    In co

    m e

    Sh ar

    e

    N ex

    t 9 %

    M ar

    gi na

    l T ax

    R at

    e NEXT 9% INCOME SHARE AND MARGINAL TAX RATE IN THE US

    Next 9% Marginal Tax Rate Next 9% Income Share

  • INSIGHTS FROM TOP INCOME SHARE ANALYSIS

    1. The top-percentile share started to increase precisely in 1981 when

    the top MTR started to decline.

    2. A sharp jump in the top-percentile share in 1986-1988 corresponds

    exactly to the sharp drop in the top MTR enacted by TRA86.

    3. The top-percentile share continues to increase in the 1990s despite

    increases in the top MTR.

    4. The income share for the 90th-99th percentile is very smooth and

    displays no correlation with the MTR for this group.

    ⇒ Circumstantial evidence that the ETIwill be strongly heterogeneous across reforms/time periods and across income groups.

  • FELDSTEIN (1995): TRA86

    Studies TRA86 as a natural experiment.

    TRA86 is the most fundamental tax reform in the US since WWII.

    TRA86 lowered the top MTR from 50% to 28% phased in over two

    years, with smaller tax cuts further down the distribution.

    The reform also involved substantial base-broadening by repealing ex-

    emptions and preferential tax treatment.

  • FELDSTEIN (1995): EMPIRICAL STRATEGY

    Uses a panel of individual tax returns. Compares years 1985 and 1988.

    Exploit differences in marginal tax cuts across the income distribution:

    Treatment group = highest-income taxpayers in 1985: 85 = 49-50%

    Control group 1 = high-income taxpayers in 1985: 85 = 42-45%

    Control group 2 = medium-income taxpayers in 1985: 85 = 22-38%

    A dif-in-dif is then used to estimate the ETI:

    ˆ = ∆ ln −∆ ln

    ∆ ln ¡ 1−

    ¢ −∆ ln

    ¡ 1−

    ¢

    where is taxable income.

  • CHANGES IN TAX RATES AND REPORTED INCOMES BETWEEN 1985 AND 1988INCOMES BETWEEN 1985 AND 1988

    Source: Feldstein (1995)

  • DIFFERENCE-IN-DIFFERENCES: THE ELASTICITY OF TAXABLE INCOMETHE ELASTICITY OF TAXABLE INCOME

    Source: Feldstein (1995)

  • PROBLEMS WITH FELDSTEIN’S APPROACH

    (1) If inequality increases for non-tax reasons, the ETI is biased upwards as the dif-in-dif attributes all of the differential increase in top

    incomes to the tax reform.

    (2) Defining treatment and control by pre-reform income level creates

    a mean-reversion problem. For ta