Sufficient Statistic or Not? The Elasticity of Taxable Income in the Presence of Deduction Possibilities

29 Pages Posted: 15 Oct 2014 Last revised: 14 Nov 2014

See all articles by Philipp Doerrenberg

Philipp Doerrenberg

ZEW – Leibniz Centre for European Economic Research; IZA Institute of Labor Economics; CESifo (Center for Economic Studies and Ifo Institute)

Andreas Peichl

ZEW – Leibniz Centre for European Economic Research; University of Mannheim - School of Economics (VWL); IZA Institute of Labor Economics; University of Essex - Institute for Social and Economic Research (ISER)

Sebastian Siegloch

IZA Institute of Labor Economics; University of Mannheim - Department of Economics; ZEW – Leibniz Centre for European Economic Research - Corporate Taxation and Public Finance Research; CESifo (Center for Economic Studies and Ifo Institute)

Date Written: October 7, 2014

Abstract

The elasticity of taxable income (ETI) is often interpreted as a sufficient statistic to assess the welfare costs of taxation. Building on the conceptual framework of Chetty (2009), we show that this assertion does no longer hold for tax systems with deduction possibilities if (i) deductions generate externalities and (ii) deductions are responsive to tax rate changes. While the first condition should arguably hold for almost any imaginable tax deduction, we provide a thorough 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 baseline estimates indicate an overall ETI of 0.49 and an elasticity of deductions with respect to the net-of-tax rate of -2.80. Given that the majority of deductions in the German income tax system generate externalities, our nonzero deduction elasticity suggests that the ETI is not sufficient to calculate the welfare cost of taxation.

Keywords: elasticity of taxable income; deductions; tax expenditures; sufficient statistic; administrative data; Germany

JEL Classification: H24, H31

Suggested Citation

Doerrenberg, Philipp and Peichl, Andreas and Siegloch, Sebastian, Sufficient Statistic or Not? The Elasticity of Taxable Income in the Presence of Deduction Possibilities (October 7, 2014). ZEW - Centre for European Economic Research Discussion Paper No. 14-078. Available at SSRN: https://ssrn.com/abstract=2509230 or http://dx.doi.org/10.2139/ssrn.2509230

Philipp Doerrenberg (Contact Author)

ZEW – Leibniz Centre for European Economic Research ( email )

P.O. Box 10 34 43
L 71
D-68034 Mannheim, 68034
Germany

IZA Institute of Labor Economics ( email )

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

CESifo (Center for Economic Studies and Ifo Institute) ( email )

Munich
Germany

Andreas Peichl

ZEW – Leibniz Centre for European Economic Research ( email )

P.O. Box 10 34 43
L 7,1
D-68034 Mannheim, 68034
Germany

University of Mannheim - School of Economics (VWL) ( email )

Mannheim 68131
Germany

IZA Institute of Labor Economics ( email )

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

University of Essex - Institute for Social and Economic Research (ISER)

Wivenhoe Park
Colchester CO4 3SQ
United Kingdom

Sebastian Siegloch

IZA Institute of Labor Economics ( email )

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

University of Mannheim - Department of Economics ( email )

D-68131 Mannheim
Germany

ZEW – Leibniz Centre for European Economic Research - Corporate Taxation and Public Finance Research ( email )

United States

CESifo (Center for Economic Studies and Ifo Institute) ( email )

Poschinger Str. 5
Munich, DE-81679
Germany

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