Tax Bases, Tax Rates and the Elasticity of Reported Income

Abstract

Tax reforms usually change both tax rates and tax bases. Using a panel of income tax returns spanning the two major U.S. tax reforms of the 1980s and a number of smaller tax law changes, I find that the elasticity of income reported on personal income tax returns depends on the available deductions. This highlights that this key behavioral elasticity is not a structural parameter but rather that it can be to some extent controlled by policy makers. The results suggest that base broadening reduces the marginal efficiency cost of taxation. The point estimates indicate that the Tax Reform Act of 1986 reduced the marginal cost of collecting a dollar of tax revenue by 2 cents, with roughly half of this reduction due to the base broadening and the other half due to the tax rate reduction. As a by-product, the analysis in this paper offers a reconciliation of disparate estimates obtained by previous studies of the tax responsiveness of income.