23 Apr
Gruber, Jon and Emmanuel Saez (2002). “The elasticity of taxable income: evidence and implications.” Journal of Public Economics. 1 Research question • What is the elasticity of income with respect to marginal income tax rate? • Economic reasoning/motivation 2 Data • Use the public-use version of the 1979-1990 NBER panel tax returns data to examine both taxable income and broad income responses to both the 1981 tax change and the Tax Reform Act of 1986. • Measure behavioral changes (between paired observations) over three-year intervals, which provides them with variation in tax rates across time for all income levels and a longer period for behavioral responses to occur. • Furthermore, because they incorporate state as well as federal income tax changes, they also have cross-sectional variations in tax rate changes within income groups. • Income definition – Broad income: wage income, interest income, dividends, business income, etc. (i.e., income before deductions) – Taxable income: includes items and adjustments • Exclusions: 1 – Exclude taxpayers whose marital status changes, to control for large income changes unrelated to tax policy. – Capital gains are excluded from both income definitions, because tax rules are significantly different. – Exclude taxpayers with income less than $10k a year, to avoid serious mean reversion. 3 Empirical design • Use variation in tax rates from tax reforms in the 1980s. – Income tax schedule: 15 → 4 brackets. – Top marginal rate: 70% → 28%. • Exogenous variation: change in tax law • Identification strategy: control for the relationship between income changes and lagged income levels. • Model zit = z 0 it(1 − τit) e , where z 0 it is potential income (if τit = 0), τit = T 0 t (zit) is marginal tax rate, and e is elasticity of taxable of income (ETI). Taking logs, we get the regression equation log zit+3 zit = α + e · log 1 − τit+3 1 − τit + εit. • Instrumental variation (IV) regression – The identification problem in the regression equation above is that the independent variable is correlated with the error term (because the τit is a function of zit). – Instrument: predicted change in marginal rate of income tax (τit), assuming income stays constant (or grows at the rate of overall nominal income growth). log 1 − τˆit+3 1 − τit – This simulated instruments isolates changes in tax law (i.e., Tt(·)) as the only source of variation in tax rates. – The second stage regresses the log of income growth against the change in the log of the net-of-tax rate, year fixed effects, and dummies for marital status. 2 4 Main findings and implications 16 J. Gruber, E. Saez / Journal of Public Economics 84 (2002) 1 –32 Table 4 a Basic elasticity results Income controls None Log income Log income 10-piece spline Broad Taxable Broad Taxable income income income income Broad Taxable (1) (2) (3) (4) income income (5) (6) Elasticity 20.300 20.462 0.170 0.611 0.120 0.400 (0.120) (0.194) (0.106) (0.144) (0.106) (0.144) Dummy for marrieds 20.008 20.062 0.045 0.049 0.050 0.055 (0.010) (0.018) (0.014) (0.023) (0.012) (0.021) Dummy for singles 20.037 20.053 20.034 20.032 20.036 20.027 (0.012) (0.019) (0.013) (0.022) (0.013) (0.021) Log(income) control 20.083 20.167 (0.015) (0.021) Spline 1st decile control 0.225 20.884 (0.086) (0.039) Spline 2nd decile control 22.74 20.538 (1.13) (0.047) Spline 3rd decile control 20.317 20.279 (0.055) (0.057) Spline 4th decile control 20.071 20.445 (0.051) (0.069) Spline 5th decile control 20.197 20.003 (0.054) (0.075) Spline 6th decile control 20.074 20.253 (0.053) (0.081) Spline 7th decile control 20.127 20.124 (0.056) (0.083) Spline 8th decile control 20.061 20.0172 (0.057) (0.083) Spline 9th decile control 20.027 20.057 (0.076) (0.125) Spline 10th decile control 20.072 20.126 (0.041) (0.064) Observations: 69 129 59 199 69 129 59 199 69 129 59 199 a Estimates from 2SLS regressions. Income range is $10 000 and above. Regressions weighted by income. All regressions include dummies for marital status and dummies for each base year. endpoints. In practice, the results are fairly sensitive to the first restriction; our overall elasticity is only about three-quarters as large when we use an uncapped weight, and the elasticity at the top of the income distribution is only about 60% as 9 large. The results are not very sensitive to the second restriction. 9 We have decided to censor these observations because we did not want to allow a few outliers to drive our main estimates. Moreover, when we allow for income-specific time trends in our specification check section, we obtain the same elasticity as in Table 4 both with and without this censoring, as the influence of these outliers is captured by these additional time trend terms. So we feel that the estimate in Table 4 is the best estimate of the true responsiveness of taxable income to taxation. • Three alternative ways to address the issues of mean reversion and income distribution changes. • Overall ETI is 0.4. • Elasticity for broad income is much lower than that for taxable income. This suggests that much of the taxable income response comes through deductions, exemptions, and exclusions. • Heterogeneity by income group: higher ETI for high-income group and lower ETI for lowincome group. • Policy implication: Optimal tax structures should be (a) tightly targeted transfers to lowincome taxpayers and (b) flat/declining marginal rate structure for mid- and high-income taxpayers. 5 Limitations • Results are not robust. – Sensitive to exclusion of low incomes – Sensitive to controls for mean reversion – Subsequent studies find smaller elasticities using data from other countries (Kleven and Schultz 2014 AEJ-EP) – Bundles together small tax changes and large tax changes: if individuals respond only to large changes in short-medium run, then estimated elasticity is too low (Chetty et al. 2011 QJE] 3 Weber, Caroline (2014). “Toward obtaining a consistent estimate of the elasticity of taxable income using difference-in-differences.” Journal of Public Economics. Weber (2014) argues for constructing the tax rate instrument to be a function of income lagged one or more years before the base year, with the appropriate lag depending on the degree of serial correlation of transitory income; in this framework, addressing heterogeneous income trends requires that one-year income controls be instrumented with income from the same lag as for the tax rate variables. 4
Paper summary Use the paper from the list below. Summarize (1) the primary question of the paper and the economic reasoning, (2) the data used by the author(s), (3) the empirical design, and (4) the main findings and insights. (5) Lastly, describe any shortcomings in the data or empirical design that you see. – No more than three pages, no citation allowed. – Use subtitles to make your summaries clearly. – See the guideline that I gave you to have a basic idea. Papers to choose from: Goolsbee, Austan. (2000) What happens when you tax the rich? Evidence from executive compensation. Journal of Political Economy 108 (2), 352–378.
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