How do Top Earners Respond to Taxation? Evidence from a Tax Reform in Uruguay

Abstract

In this paper, we analyze how top income earners (TIEs) respond to changes in personal income taxation. Using an unprecedented combination of administrative records from the Tax and Social Security Agencies that covers most sources of personal income, we exploit a unique reform to Uruguay’s progressive labor income tax schedule that generated quasi-random variation in the marginal tax rates affecting labor income earners in the top 1% of the distribution. Using a difference-in-differences design, we estimate the elasticities on the intensive, extensive, and income shifting margins to changes in the labor income tax rates. Our preferred specification estimates an intensive margin elasticity of 0.577, which is partially explained by a real labor supply adjustment through fewer hours worked. Responses on the extensive margin are larger. Our preferred estimates indicate an extensive margin semi-elasticity of 2.479, which is mostly driven by shifts from the labor to the corporate income tax base (with a semi-elasticity of -1.967). Based on a simple model that allows individuals to choose between different tax bases, we estimate that the efficiency costs of the reform are, at most, 31.3% of the projected tax revenue.

Keywords: Income taxation, top income earners, tax reform, reported income supply, income-shifting

JEL Classification: H21, H24, H30, J22, O23