How to Use One Instrument to Identify Two Elasticities

35 Pages Posted: 27 Mar 2017

See all articles by Evelina Gavrilova

Evelina Gavrilova

Norwegian School of Economics (NHH) - Department of Business and Management Science

Floris Zoutman

Norwegian School of Economics (NHH) - Department of Business and Management Science

Arnt Hopland

Norwegian School of Economics (NHH)

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Date Written: March 06, 2017

Abstract

We show that an insight from taxation theory allows identification of both the supply and demand elasticities with only one instrument. Ramsey (1928) and subsequent models of taxation assume that a tax levied on the demand side only affects demand through the price after taxation. Econometrically, we show that this assumption functions as an additional exclusion restriction. Under the Ramsey Exclusion Restriction (RER) a tax reform can serve to simultaneously identify elasticities of supply and demand. We develop a TSLS estimator for both elasticities, a test to assess instrument strength and a test for the RER. Our result extends to a supply-demand system with J goods, and a setting with supply-side or non-linear taxes. Further, we show that key results in the sufficient statistics literature rely on the RER. One example is Harberger’s formula for the excess burden of a tax. We apply our method to the Norwegian labor market.

Keywords: tax reform, instrumental variable, supply and demand elasticities, tax incidence, payroll taxation

JEL Classification: C360, H220, H310, H320, J220, J230

Suggested Citation

Gavrilova, Evelina and Zoutman, Floris and Hopland, Arnt, How to Use One Instrument to Identify Two Elasticities (March 06, 2017). CESifo Working Paper Series No. 6379, Available at SSRN: https://ssrn.com/abstract=2941442

Evelina Gavrilova

Norwegian School of Economics (NHH) - Department of Business and Management Science ( email )

Helleveien 30
Bergen, 5045
Norway
4741152047 (Phone)

Floris Zoutman (Contact Author)

Norwegian School of Economics (NHH) - Department of Business and Management Science ( email )

Helleveien 30
Bergen, NO-5045
Norway

Arnt Hopland

Norwegian School of Economics (NHH)

Helleveien 30
Bergen, NO-5045
Norway

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