Diffuse Bunching with Frictions: Theory and Estimation

72 Pages Posted: 12 Jul 2022 Last revised: 13 Oct 2022

See all articles by Santosh Anagol

Santosh Anagol

University of Pennsylvania - Wharton School of Business - Business Economics and Public Policy Department

Allan Davids

University of Cape Town (UCT)

Benjamin B Lockwood

University of Pennsylvania - The Wharton School

Tarun Ramadorai

Imperial College London; Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI)

Date Written: October 13, 2022

Abstract

We incorporate a model of frictions into the bunching-based elasticity estimator to rationalize diffuse bunching around kinks and mass above notches in empirical distributions. Model agents draw a sparse set of opportunities from a Poisson process, approximating a broad class of frictions including search costs, inattention, and lumpy adjustment; the predicted density depends on the standard structural elasticity and a money-metric “lumpiness parameter.” We estimate the model using administrative tax data on South African small-businesses, recovering moderate elasticities of taxable income between 0.2 and 0.3 at higher incomes, and larger elasticities at low incomes. Firms appear to treat the bottom kink as a notch, and firms with paid tax practitioners exhibit sharper bunching, driven primarily by lower frictions rather than a higher elasticity.

Keywords: diffuse bunching, sparsity, lumpy adjustment, optimization frictions, elasticity of taxable income, tax, small business, South Africa

JEL Classification: D22, H20, H25, H30, O55

Suggested Citation

Anagol, Santosh and Davids, Allan and Lockwood, Benjamin B and Ramadorai, Tarun, Diffuse Bunching with Frictions: Theory and Estimation (October 13, 2022). Available at SSRN: https://ssrn.com/abstract=4152124 or http://dx.doi.org/10.2139/ssrn.4152124

Santosh Anagol

University of Pennsylvania - Wharton School of Business - Business Economics and Public Policy Department ( email )

3641 Locust Walk
Philadelphia, PA 19104-6372
United States

Allan Davids

University of Cape Town (UCT) ( email )

Private Bag X3
Rondebosch, Western Cape 7701
South Africa

Benjamin B Lockwood (Contact Author)

University of Pennsylvania - The Wharton School ( email )

3641 Locust Walk
Philadelphia, PA 19104-6365
United States

Tarun Ramadorai

Imperial College London ( email )

South Kensington Campus
Exhibition Road
London, Greater London SW7 2AZ
United Kingdom

HOME PAGE: http://www.tarunramadorai.com

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

European Corporate Governance Institute (ECGI) ( email )

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

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