Scandinavian Working Papers in Economics

Working Papers,
Lund University, Department of Economics

No 2004:5: Taxpayers Responsiveness to Tax Rate Changes and Implications for the Cost of Taxation

Åsa Hansson ()
Additional contact information
Åsa Hansson: Department of Economics, Lund University, Postal: Department of Economics, School of Economics and Management, Lund University, Box 7082, S-220 07 Lund, Sweden

Abstract: The elasticity of taxable income with respect to net-of-tax rate is key in evaluating tax policies and predicting tax revenue effects. This paper estimates the elasticity of taxable income for Swedish taxpayers using two different approaches and a number of control variables using the 1990/1991 tax reform as a “natural experiment“. The preferred elasticity estimates fall in the range of 0.4 to 0.5, numbers comparable with recent estimates for the U.S., but higher than most estimates of the labor supply elasticity in Sweden. Therefore, tax policy evaluations based on labor supply elasticities are likely to underestimate taxpayer response to tax rate changes and to overestimate potential tax revenues from tax rate increases. Re-estimating the deadweight loss of labor taxation using my estimates of elasticity of taxable income, I find that deadweight loss may be substantially higher than suggested by estimates based on labor supply elasticities.

Keywords: Tax reform; taxable income elasticity; natural experiment; deadweight loss

JEL-codes: H21; H24; H31; J22

32 pages, February 2, 2004

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