The Elasticity of Taxable Income in the Presence of Deduction Possibilities

38 Pages Posted: 4 Jun 2015

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: May 30, 2015

Abstract

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 taxbase 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 0.35 and 0.68 and an elasticity of deductions with respect to the net-of-tax rate between -0.3 and -0.9. These results suggest 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: H240, H310

Suggested Citation

Doerrenberg, Philipp and Peichl, Andreas and Siegloch, Sebastian, The Elasticity of Taxable Income in the Presence of Deduction Possibilities (May 30, 2015). CESifo Working Paper Series No. 5369. Available at SSRN: https://ssrn.com/abstract=2613909

Philipp Doerrenberg

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 (Contact Author)

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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