The Elasticity of Taxable Income and Income-Shifting: What is 'Real' and What is Not?

Abstract

Standard-Nutzungsbedingungen:Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden.Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen.Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. Previous literature shows that income taxation significantly affects the behavior of highincome earners and business owners. However, it is still unclear how much of the response is due to changes in effort and other real economic activity, and how much is caused by tax avoidance and tax evasion. This distinction is important because it affects the welfare implications and policy recommendations. In this paper we distinguish between real responses and tax-motivated income-shifting between tax bases. We show how the explicit inclusion of income-shifting affects the welfare analysis of income taxation. In our empirical example we find that income-shifting accounts for over two thirds of the overall elasticity of taxable dividend income among Finnish business owners. The large income-shifting response significantly decreases the marginal excess burden compared to the standard model in which the overall elasticity defines the welfare loss. However, in addition to income-shifting, we find that dividend taxation significantly affects the real behavior of owners. Terms of use: Documents inJEL-Code: H240, H250, H320.

Elasticity of Taxable Income: Evidence from Changes in Municipal Income Tax Rates in Finland

“…Previous US studies show that a large proportion of the behavioral response of high‐income individuals has been in the form of tax avoidance via income‐shifting (see, e.g., Saez et al ., ). Harju and Matikka () show that a similar result holds for the owners of privately held businesses in Finland. In addition, the US studies have shown that charitable giving, which is tax‐deductible in the US, responds to changes in marginal tax rates (see, e.g., Bakija and Heim, ).…”

“…However, I do not find the ETI to be larger among high‐income earners compared with middle‐income individuals, although many previous studies have found different results. One potential explanation for this finding is that available tax avoidance opportunities are in general very limited even among high‐income earners in Finland (with the exception of the owners of privately held corporations; see Harju and Matikka, ). In contrast, the larger estimates among top income earners in the earlier studies, particularly in the US, tend to be driven by tax avoidance responses (Saez et al ., ).…”

“…The main exception is owners of privately held corporations. Harju and Matikka () present an ETI analysis of wage and dividend taxation in the presence of income‐shifting among these business owners. For the entire population in this study, the ETI estimates are not sensitive to excluding individuals with significant capital income ( > 1,000 euros), highlighting that income‐shifting is not driving the overall results.…”

Income Shifting in the Spanish Dual Income Tax*

“…Our paper also relates closely to the line of research cited above, which analyses the choice of remuneration regime for business owners (wages or dividends), especially the work of Harju and Matikka (). These authors analyse income shifting in a very similar way to our approach here, using the tax rate differential between wages and dividends to measure income shifting between them after the 2005 reform in Finland.…”

“…To analyse the incentives for taxpayers to decide the composition of their income based on the different taxes charged on its components, we will extend a simple static model of income shifting developed by Piketty and Saez (), Piketty, Saez and Stantcheva () and Harju and Matikka ()…”