Estimating Taxable Income Responses with Elasticity Heterogeneity
22 Pages Posted: 10 Nov 2016 Last revised: 29 Apr 2020
Date Written: 2016-11-01
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 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 Classification: D11, H24, J22
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