Scandinavian Working Papers in Economics

Working Paper Series, Center for Fiscal Studies,
Uppsala University, Department of Economics

No 2015:1: The Taxable Income Elasticity: A Structural Differencing Approach

Anil Kumar () and Che-Yuan Liang ()
Additional contact information
Anil Kumar: Research Department, Federal Reserve Bank of Dallas
Che-Yuan Liang: Uppsala Center for Fiscal Studies, Postal: Department of Economics, Uppsala University, P.O. Box 513, SE-751 20 Uppsala, Sweden

Abstract: We extend a standard taxable income model with its typical functional-form assumptions to account for nonlinear budget sets. We propose a new method to estimate a taxable income elasticity that is more policy relevant than the typically estimated elasticity based on linearized budget sets. Using U.S. data from the NBER tax panel for 1979-1990 and differencing methods, we estimate an elasticity of 0.75 for taxable income and 0.20 for broad income. These estimates are higher than those obtained by specifications based on linearization. Our approach offers a new way to address the problem of endogenous observed marginal tax rates.

Keywords: taxable income; nonlinear budget sets; panel data

JEL-codes: D11; H24; J22

21 pages, January 7, 2015

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