Diffuse Bunching with Lumpy Incomes: Theory and Estimation

66 Pages Posted: 12 Jul 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: July 1, 2022

Abstract

We study the performance of the bunching-based elasticity estimator when income adjustments are lumpy. In our parsimonious model, taxpayers choose their preferred income from random opportunity sets. The model features the standard elasticity of taxable income and a single additional “lumpiness parameter,” which can be jointly estimated using maximum likelihood. This model can match key patterns that are inconsistent with the conventional bunching estimator, including diffuse bunching around kinks and notches in the tax schedule and positive mass above tax notches. When incomes are lumpy, simulations demonstrate that the conventional estimator is biased, underestimating the true elasticity by as much as 50%, and incorrectly sized, with the true parameter lying inside bootstrap 95% confidence intervals with less than 10% probability. We apply this method to administrative tax data on small businesses in South Africa, recovering moderate elasticities at higher incomes and large elasticities at low incomes. Firms with paid tax practitioners exhibit sharper bunching, driven primarily by a lower lumpiness parameter rather than by a different income elasticity.

Keywords: diffuse bunching, lumpy incomes, 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 Lumpy Incomes: Theory and Estimation (July 1, 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

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
13
Abstract Views
81
PlumX Metrics