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Estimating the Elasticity of Taxable Income: Evidence from Top Japanese Taxpayers
Abstract
This study aims to estimate the elasticity of taxable income (ETI) with regard to the net-of-tax rate, precisely in terms of potential for the margin arising from the behavioral response. We use panel data from top Japanese taxpayers in Tokyo during 1986–1989 and focus on the tax policy changes caused by the 1987–1989 comprehensive tax reform, which substantially reduced the top marginal tax rates. It is found that the ETI with regard to the net-of-tax rate is approximately 0.158–0.226, considerably lower than those for the United States and many European countries. One possible reason for the small ETI estimates is the absence of the behavioral response in terms of choice of deductions in this study.
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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 real economic activity, and how much is caused by tax avoidance. In this paper, we distinguish between real responses and income-shifting between tax bases. We show that separating income-shifting responses can largely affect the welfare analysis of income taxation. In our empirical example of Finnish business owners, we find that income-shifting accounts for a majority of the overall elasticity of taxable income, which significantly decreases the marginal excess burden.
This study explores the effects of spousal allowances (SAs) in the Japanese system of personal income taxes, using the micro-simulation method based on the discrete choice model of labor supply. Our simulations show that the complete abolishment of SAs would increase the average annual working hours of all wives by 1.6% only, which is smaller than previous findings in the Japanese literature. If we focus on households benefiting from SAs, the rate of increase in the wife’s working hours is even smaller (.1%). In addition, one particular case of SA reduction leads to a decrease in the labor supply of wives. We argue that these unexpected results are due to our explicit consideration of the fixed cost of labor market participations, which has been previously ignored in the Japanese studies.
The paper studies how high-income taxpayers responded to the introduction of the ‘extraordinary tax on individuals’ in Hungary in 2007. The study is based on a panel of tax returns containing information on 10 percent of tax-filers from 2005 and three subsequent years. We estimate the elasticity of taxable income with respect to the marginal net-of-tax rate and find that the taxable income of Hungarian high earners is moderately responsive to taxation: the estimated elasticity is about 0.24. We also find evidence for a sizeable income effect. The estimated effect is not caused by income shifting.
Several studies, conducted on U.S. data, have found rather strong income responses to changes in net-of-tax rates when treating tax reforms as "natural experiments" and applying the differences-of-differences estimator. Like the U.S. Tax Reform Act of 1986, the Norwegian tax reform of 1992 entailed substantial increases in the net-of-tax rate for high-income earners. This paper provides measures of the elasticity of taxable income with respect to these tax rate changes. We control for the impact of other tax changes and several non-tax factors on income growth. Our estimates of the elasticity of taxable income with respect to the net-of-tax rate range between -0.6 and 0.2, substantially lower than similar estimates from analyses on U.S. data.
This paper critically surveys the large and growing literature estimating the elasticity of taxable income with respect to marginal tax rates using tax return data. First, we provide a theoretical framework showing under what assumptions this elasticity can be used as a sufficient statistic for efficiency and optimal tax analysis. We discuss what other parameters should be estimated when the elasticity is not a sufficient statistic. Second, we discuss conceptually the key issues that arise in the empirical estimation of the elasticity of taxable income using the example of the 1993 top individual income tax rate increase in the United States to illustrate those issues. Third, we provide a critical discussion of selected empirical analyses of the elasticity of taxable income in light of the theoretical and empirical framework we laid out. Finally, we discuss avenues for future research. ( JEL H24, H31, J22)
Federal tax reform in 1988 flattened the Canadian personal income tax schedule, changing the marginal tax rates for many individuals. Using methods similar to those applied by Auten and Carroll [Rev. Econ. 81(4) (1999) 681] in the study of the effects of the 1986 U.S. Tax Reform Act, we estimate the responsiveness of income to changes in taxes to be substantially smaller in Canada. However we find evidence of a much higher response in self-employment income, in the labor income of seniors and from those with high incomes.
Historically, labor supply elasticities have been used to evaluate tax policy and predict tax revenue effects. They are likely
to underestimate taxpayers' response to tax rate changes, and hence to underestimate changes in potential tax revenues, however,
because they measure only how taxpayers alter hours worked. Taxpayers can also respond to tax rate changes by altering, for
instance, their work effort and form of compensation. An alternative measure that accounts for these responses as well as
hours worked is the elasticity of taxable income. This paper estimates the elasticity of earned taxable income for Swedish
taxpayers using two different approaches and a number of control variables and the 1990/1991 tax reform as a “natural experiment”.
The preferred elasticity estimates fall in the range of 0.4–0.5, comparable with recent estimates for the U.S. and larger
than most of the labor supply elasticity estimates used to evaluate tax policy in Scandinavia previously, which suggests that
deadweight losses are two to three times higher than previously thought.
Several recent studies show that the elasticity of taxable income (ETI) is not a sufficient statistic for the welfare costs of taxation due to factors such as tax-base shifting. This paper provides an additional argument demonstrating the non-sufficiency of the ETI, namely tax deductions. Building on a theoretical framework which incorporates deductions in a standard optimal-tax model, we show that the ETI is not sufficient for welfare analysis if (i) deductions generate externalities and if (ii) deductions are responsive to tax-rate changes. While the first condition should arguably hold true for the majority of tax deductions, we provide an empirical examination of the second condition. Relying on rich German panel data from administrative tax records, we exploit several tax reforms that were implemented in Germany between 2001 and 2008. Our main estimates indicate an overall ETI between 0.54 and 0.68 and an elasticity of deductions with respect to the net-of-tax rate of about -0.9. These results suggest that the ETI is not sufficient to calculate the welfare cost of taxation.
The elasticity of taxable income (ETI) is a central parameter for tax policy debates. This paper shows that mean reversion prevents most estimators employed in the literature from obtaining consistent estimates of the ETI. A new method is proposed that will resolve inconsistency due to mean reversion under testable assumptions regarding the degree of serial correlation in the error term. Using this procedure, I estimate an ETI of 0.858, which is about twice as large as the estimates found in themost frequently cited paper on this subject [13]. The corresponding elasticity of broad income is 0.475.
This study proposes a method to obtain the social marginal costs of public funds (SMCF) that allows for heterogeneity on a household basis as well as labor supply responses along both the extensive and the intensive margins. To demonstrate our methodology, we take the example of the 1999 national income tax reform in Japan and evaluate it by estimating the SMCFs for changing marginal tax rates in different income brackets. We estimate the discrete choice model (DCM) of labor supply using a 1997 data set of Japanese households, and we use the estimates to generate the SMCFs with a DCM micro-simulation. We evaluate the simulated SMCFs with various distributional weights and find that the value of the SMCF for a 1% increase in the marginal tax rate in any given income bracket decreases as we move across brackets from the bottom to the top. This finding suggests that the national government should have made the Japanese income tax system more progressive rather than less progressive as carried out in the 1999 reform. Our method is readily transferable to tax reforms in other countries as well.
This paper presents evidence on taxable income responses using administrative data that link tax return information to detailed socioeconomic information for the entire Danish population over 25 years. The identifying variation is provided by a series of tax reforms that create large tax variation across individuals, income forms, and over time. It is argued that the unique tax variation and data in Denmark makes it possible to control for the biases from non-tax changes in the income distribution and mean reversion that plague much of the existing literature. Our main findings are the following: (i ) Labor income elasticities are modest overall, around 0.05 for wage earners and 0.10 for self-employed individuals. (ii ) Capital income elasticities are about 2-3 times larger than labor income elasticities. (iii ) Behavioral elasticities are much larger when estimated from large tax reform episodes than for small tax reform episodes, consistent with idea that responses to small tax changes are attenuated by optimization frictions such as adjustment costs and inattention. (iv) Crosstax effects between labor and capital income–for example due to income shifting–are in general small. (v) All of our findings are extremely robust to specification (such as pre-reform income controls), suggesting that we have controlled in a sufficiently rich way for non-tax factors impacting on taxable income.
In this paper, we estimate labor responses of Japanese prime-age males by taking into consideration the Japanese income tax system and utilizing a large micro-data set. We employ three maximum likelihood methods: (i) a modified version of (Hausman, 1979) and (Hausman, 1981), which assumes a linear labor supply function; (ii) that given by Zabalza (1983), which assumes CES preferences; and (iii) that given by Van Soest (1995), which employs the translog utility function and assumes discrete labor hour choice. While the estimates based on the Hausman and Zabalza methods fare poorly, those based on the Van Soest method result in more plausible labor responses. However, these responses are larger than those of the North American and European counterparts.
In this study, we recast the formula of the social marginal cost of public funds (SMCF) and highlight the role of what we call individual marginal costs of public funds (IMCF). After elaborating on aspects of distributional weights, we estimate the wage elasticity of labor supply and the IMCFs on a household basis. This allows us to explore not only the distributions of the elasticity and the IMCFs but also their relations to household income, which helps us assess the assumptions made in previous studies. Further, we use the SMCF estimates to evaluate the system of personal income taxes in Japan.
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 estimate small income effects of 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 the elasticity is less than one-third as large. Moreover, high income taxpayers who itemize are particularly responsive to taxation. Our estimates suggest that optimal tax structures may feature tightly targeted transfers to lower income taxpayers and a flat or even declining marginal rate structure for middle and high income taxpayers.
We argue that tax policy in Japan is on a shaky empirical ground. First, until recently, no serious attempts had been made to estimate labour responses to taxation, especially with respect to prime-age male workers. Second, while there is some stock of empirical analysis on labour supply response of female workers, few studies have appropriately allowed for the budget constraint structure implied by the tax system. Third, as a corollary, there is not a reliable stock of empirical estimates to quantify the frequently employed concepts of “disincentives to work” or “distortion.” Given this state of the literature, we introduce our estimates, and calculate the degree of distortion using the concept of the marginal cost of public funds.
The strength of the behavioral response to a tax rate change depends on the environment individuals operate in, and may be manipulated by instruments controlled by the government. We first derive a measure of the social benefit to affecting this elasticity. The paper then examines this effect in the solution to the optimal income taxation problem when such an instrument is available, first in a general model and then in an example when the government chooses the income tax base.
From book description:
Modern labor economics has continued to grow and develop since the first volumes of this Handbook were published. The subject matter of labor economics continues to have at its core an attempt to systematically find empirical analyses that are consistent with a systematic and parsimonious theoretical understanding of the diverse phenomenon that make up the labor market. As before, many of these analyses are provocative and controversial because they are so directly relevant to both public policy and private decision making. In many ways the modern development in the field of labor economics continues to set the standards for the best work in applied economics. This volume of the Handbook has a notable representation of authors - and topics of importance - from throughout the world.
This paper measures the response of taxpayers to the U.S. personal rate reductions from 1982 to 1984. A baseline income distribution is created to describe what level and distribution could be expected in the absence of tax changes. Comparison of this baseline with actual tax return data shows that at least one-sixth, and probably one-quarter, of the revenue ascribable to the rate reductions was recouped by changes in taxpayer behavior. The data also show that federal income tax revenue would have been maximized at a tax rate of about 35 percent, and total income tax revenue maximized at a total tax rate of about 40 percent.
Recently, a voluminous literature estimating the taxable income elasticity has emerged as an important field in empirical public economics. However, to a large extent it is still unknown how the hourly wage rate, an important component of taxable income, reacts to changes in marginal tax rates. In this study we use a rich panel data set and a sequence of tax reforms that took place in Sweden during the 1980s to estimate the elasticity of the hourly wage rate as well as the taxable labor income elasticity with respect to the net-of-tax rate. We also estimate elasticities with respect to the non-labor income in a way that is novel in the literature. While carefully accounting for the endogeneity of marginal tax rates we find a statistically significant response in wage rates both among married men and women. The estimates of the hourly wage rate elasticity with respect to the net-of-tax rate fall in the range of 0.14–0.16 for males and 0.41–0.57 for females, whereas the corresponding taxable labor income elasticity estimates hover between 0.19–0.21 for males and 0.96–1.44 for women. Moreover, for men we find that the taxable labor income elasticity with respect to non-labor income is statistically significant; the point estimate being − 0.07. This implies that the compensated taxable labor income elasticity is about 5 percentage points higher than the uncompensated one. In general, we consider the estimates for males to be more certain and robust than the estimates for females.
Why was the Japanese consumer price index for rents so stable even during the period of the housing bubble in the 1980s? To address this question, we use a unique micro price dataset which we have compiled from individual listings (or transactions) in a widely circulated real estate advertisement magazine. This dataset contains more than 700,000 listings of housing rents over the last 20 years. We start from the analysis of microeconomic rigidity and then investigate its implications for aggregate price dynamics, closely following the empirical strategy proposed by Caballero (Caballero and Engel, 2007). We find that 90% of the units in our dataset had no change in rents per year, indicating that rent stickiness is three times as high as in the United States. We also find that the probability of rent adjustment depends little on the deviation of the actual rent from its target level, suggesting that rent adjustments are not state-dependent but time-dependent. These two results indicate that both the intensive and extensive margins of rent adjustments are small, resulting in a slow response of the CPI for rent to aggregate shocks. We show that the CPI inflation rate would have been higher by 1% point during the bubble period, and lower by more than 1% point during the period following the burst of the bubble, if Japanese housing rents were as flexible as those in the United States.
The consumption-leisure choice model implies that an exogenous change in tax rates will bring about a change in labor supply. This implication is expected to be important to labor supplied by secondary earners under a progressive tax system when spousal income alters effective marginal tax rates. This paper examines labor supply responses to the income tax changes associated with Japanese tax reforms during the 1990s. Empirical specications are presented in a way that is consistent with a life-cycle model of consumption and labor supply. A simple solution is applied to the sample-selection problem in panel data models with endogenous regressors. The results indicate that the hours-of-work elasticity with respect to the net-of-tax rate is 0.8 for married women.
This paper uses a Treasury Department panel of more than 4,000 taxpayers to estimate the sensitivity of taxable income to changes in tax rates based on a comparison of the tax returns of the same individual taxpayers before and after the 1986 tax reform. The analysis emphasizes that the response of taxable income involves much more than a change in the traditional measures of labor supply. The evidence shows an elasticity of taxable income with respect to the marginal net-of-tax rate that is at least one and that could be substantially higher. The implications for recent tax rate changes are discussed. Copyright 1995 by University of Chicago Press.
Research on the distribution of income during the 1980s has identified a trend towards increasing inequality, which may be the continuation and acceleration of trends spanning several decades. This paper explores to what extent behavioral responses to the tax changes during the 1980s may also explain the rising inequality. The 1986 Tax Reform Act is used as a natural experiment to explore the roles played by both taxes and a variety of nontax factors. Our principal finding is that both tax rates and nontax factors appear to have had significant effects on relative income growth during the late 1980s. © 2000 by the President and Fellows of Harvard College and the Massachusetts Institute of Technolog
This paper studies the evolution of income concentration in Japan from 1886 to 2005 by constructing long-run series of top income shares and top wage income shares, using income tax statistics. We find that (i) income concentration was extremely high throughout the pre-WWII period during which the nation underwent rapid industrialization; (ii) a drastic de-concentration of income at the top took place in 1938-1945; (iii) income concentration remained low during the rest of the century but shows some sign of increase in the last decade; and (iv) top income composition in Japan has shifted dramatically from capital income to employment income over the course of the twentieth century. We attribute the precipitous fall in income concentration during WWII primarily to the collapse of capital income due to wartime regulations and inflation. We argue that the change in the institutional structure under the occupational reforms made the one-time income de-concentration difficult to reverse. In contrast to the sharp increase in wage income inequality observed in the United States since 1970, the top wage income shares in Japan have remained relatively stable over the last thirty years. We show that the change in technology or tax policies alone cannot account for the comparative experience of Japan and the United States. Instead we suggest that institutional factors such as internal labor markets and union structure are important determinants of wage income concentration. Copyright by the President and Fellows of Harvard College and the Massachusetts Institute of Technology.
The Japanese tax system offers an opportunity to investigate the labor supply response of married women to the income tax and the intrahousehold resource allocation mechanism, since the deductible amount from the husband’s income decreases as the wife’s earnings increase. Using cross-section data, I structurally estimate the labor supply of married women under the piece-wise linear budget constraint created by the Japanese tax and social security system. I find that the wife’s labor supply response to her husband’s decreasing deduction tends to be greater than the response to her own income tax. This suggests that not only the unitary model is rejected but also that female labor is allocated inefficiently within a family. Finally, this study shows that the choice of household model affects the predicted effect of policy reform and that the currently proposed reforms will have less of an effect on the labor supply of married women than previous studies claim. Copyright Springer Science+Business Media, LLC 2006
We introduce a new hybrid approach to joint estimation of Value at Risk (VaR) and Expected Shortfall (ES) for high quantiles of return distributions. We investigate the relative performance of VaR and ES models using daily returns for sixteen stock market indices (eight from developed and eight from emerging markets) prior to and during the 2008 financial crisis. In addition to widely used VaR and ES models, we also study the behavior of conditional and unconditional extreme value (EV) models to generate 99 percent confidence level estimates as well as developing a new loss function that relates tail losses to ES forecasts. Backtesting results show that only our proposed new hybrid and Extreme Value (EV)-based VaR models provide adequate protection in both developed and emerging markets, but that the hybrid approach does this at a significantly lower cost in capital reserves. In ES estimation the hybrid model yields the smallest error statistics surpassing even the EV models, especially in the developed markets.
We investigate the Japanese personal income distribution in the high income range over the 112 years 1887-1998, and that in the middle income range over the 44 years 1955-98. It is observed that the distribution pattern of the lognormal with power law tail is the universal structure. However the indexes specifying the distribution differ from year to year. One of the index characterizing the distribution is the mean value of the lognormal distribution; the mean income in the middle income range. It is found that this value correlates linearly with the Gross Domestic Product (GDP). To clarify the temporal change of the equality or inequality of the distribution, we analyze Pareto and Gibrat indexes, which characterize the distribution in the high income range and that in the middle income range respectively. It is found for some years that there is no correlation between the high income and the middle income. It is also shown that the mean value of Pareto index equals to 2, and the change of this index is effected by the change of the asset price. From these analysis we derive four constraints that must be satisfied by mathematical models.
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