Sufficient Statistic or Not? The Elasticity of Taxable Income in the Presence of Deduction Possibilities

Philipp Doerrenberg, Andreas Peichl and Sebastian Siegloch

No 8554, IZA Discussion Papers from Institute of Labor Economics (IZA)

Abstract: The elasticity of taxable income (ETI) is often interpreted as a sufficient statistic to assess the welfare costs of taxation. Building on the conceptual framework of Chetty (2009), we show that this assertion does no longer hold for tax systems with deduction possibilities if (i) deductions generate externalities and (ii) deductions are responsive to tax rate changes. While the first condition should arguably hold for almost any imaginable tax deduction, we provide a thorough empirical examination of the second condition. Relying on rich German panel data from administrative tax records, we exploit several tax reforms that were implemented in Germany between 2001 and 2008. Our baseline estimates indicate an overall ETI of 0.49 and an elasticity of deductions with respect to the net-of-tax rate of -2.80. Given that the majority of deductions in the German income tax system generate externalities, our non-zero deduction elasticity suggests that the ETI is not sufficient to calculate the welfare cost of taxation.

Keywords: elasticity of taxable income; deductions; tax expenditures; sufficient statistic; administrative data; Germany (search for similar items in EconPapers)
JEL-codes: H24 H31 (search for similar items in EconPapers)
Pages: 29 pages
Date: 2014-10
New Economics Papers: this item is included in nep-pub
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Citations: View citations in EconPapers (4)

Published - revised version published as 'The elasticity of taxable income in the presence of deduction possibilities' in: Journal of Public Economics, 2017, 151, 41 - 55

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Related works:
Working Paper: Sufficient Statistic or Not? The Elasticity of Taxable Income in the Presence of Deduction Possibilities (2015)
Working Paper: Sufficient statistic or not? The elasticity of taxable income in the presence of deduction possibilities (2014)
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