Estimating Income Responses to Tax Changes: A Dynamic Panel Data Approach

39 Pages Posted: 18 Oct 2007  

Bertil Holmlund

Uppsala University - Department of Economics; CESifo (Center for Economic Studies and Ifo Institute); IZA Institute of Labor Economics

Martin Söderström

Uppsala University - Department of Economics

Date Written: October 2007

Abstract

Recent research on the behavioral effects of income taxes has to a large extent focused on the elasticity of taxable income with respect to the net-of-tax rate, i.e., one minus the marginal tax rate. We offer new evidence on this matter by making use of a large panel of Swedish tax payers over the period 1991-2002. Changes in statutory tax rates as well as discretionary changes in tax bracket thresholds provide exogenous variations in tax rates that can be used to identify income responses. We estimate dynamic income models which allow us to distinguish between short-run and long-run effects in a straightforward fashion. The estimates of the long-run elasticity of income with respect to the net-of-tax rate typically hover in a range between 0.20 and 0.30. The short-run elasticities are in general smaller but less precisely estimated. We use the estimates to simulate the fiscal consequences of a tax reform that reduces the top marginal tax rate by five percentage points. Such a reform turns out to have negligible effects on tax revenues and may even yield a fiscal surplus.

Keywords: marginal tax rates, progressive taxes, earned income, tax reform

JEL Classification: H24, H31, J22

Suggested Citation

Holmlund, Bertil and Söderström, Martin, Estimating Income Responses to Tax Changes: A Dynamic Panel Data Approach (October 2007). CESifo Working Paper No. 2121; IZA Discussion Paper No. 3088. Available at SSRN: https://ssrn.com/abstract=1022502

Bertil Holmlund (Contact Author)

Uppsala University - Department of Economics ( email )

SE-75120 Uppsala
Sweden
+46 18 471 1122 (Phone)
+46 18 471 1478 (Fax)

HOME PAGE: http://www.nek.uu.se/faculty/holmlund/index.html

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

IZA Institute of Labor Economics

P.O. Box 7240
Bonn, D-53072
Germany

Martin Söderström

Uppsala University - Department of Economics ( email )

Box 513
SE-75120 Uppsala
Sweden

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