Problematic response margins in the estimation of the elasticity of taxable income
Kristoffer Berg & Thor O. Thoresen
International Tax and Public Finance, October 2019
The elasticity of taxable income (ETI) holds the promise of representing a summary measure of tax efficiency costs, which means that further information about the behavioral components of the ETI is not required for its use in tax policy design. However, since there are response margins that can cause biases in the estimation of the elasticity, this paper warns against neglecting information about the composition of the behavior summarized by the ETI. When using responses of the Norwegian self-employed to the tax reform of 2006 for illustration, we discuss how three different response margins relate to the overall ETI: working hours, tax evasion and shifts in organizational form. We provide empirical illustrations of effects of each of these margins and argue that the standard procedure for estimating the ETI produces a biased estimate due to the organizational shift margin.