Individual Heterogeneity, Nonlinear Budget Sets, and Taxable Income
Uppsala Center for Fiscal Studies Working Paper 2014:1
45 Pages Posted: 23 Apr 2014
Date Written: January 31, 2014
Given the key role of the taxable income elasticity in designing an optimal tax system there are many studies attempting to estimate this elasticity. A problem with most of these studies is that strong functional form assumptions are used and that heterogeneity in preferences is not allowed for. Building on Blomquist and Newey (2002) we in this paper develop a nonparametric method to estimate expected taxable income as a function of a nonlinear budget set, taking multidimensional heterogeneity and optimization errors fully into account. We reduce the dimensionality of the problem by exploiting structure implied by utility maximization with piecewise linear convex budget sets. We apply the method to Swedish data and estimate for prime age males a significant net of tax elasticity of 0.6 and a significant income elasticity of -0.08.
Keywords: nonlinear budget sets, nonparametric estimation, additive models, heterogeneous
JEL Classification: C14, C24, H31, H34, J22
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