Department of Economics
Date of this Version
2008
Abstract
This paper presents applications of variants of a differencing methodology to Internal Revenue Service tax records in order to estimate taxable income elasticities for the 1990s. Estimates are systematically examined by applying a number of sensitivity tests. Estimates are produced after altering the: (1) time interval over which observational-level behavior is measured; (2) income restrictions on the sample; (3) choice of control variables; and (4) weighting scheme used in the regressions. In general, estimates are quite sensitive to a number of different factors. In contrast to some of the literature, estimates are larger when behavior is measured over 3-year intervals as opposed to over 1-year intervals, suggesting small transitory responses to tax changes but larger longer-term responses. When including the richest set of income controls, income-weighted short-term elasticity estimates (based on 1-year differencing) range from 0 to 0.19. Similarly estimated longer-term elasticities (where data are differenced over 3-year intervals) are about 0.32. When adding adjacent year tax rates to the model, short-term elasticity estimates range from 0.30 to 0.43 and longer-term estimates from 0.97 to 1.37. In most cases, estimates from an end-year approach (which includes only 2 years of data, one well before the tax change and one well after) are not statistically different from 0. However, even for the approaches that produce statistically significant results, estimates are sensitive to an array of factors and plausible sensitivity checks often result in estimates that differ greatly. A major conclusion is that isolating the true taxable income responses to tax changes is inherently complex and little confidence should be placed on any single estimate.
Comments
Published in Congressional Budget Office, Washington, D.C., September 2008. Used by permission.