Type of Document Dissertation Author Acuna, Hernan Mauricio Author's Email Address firstname.lastname@example.org URN etd-11142009-181558 Title On the Effect of Personal Taxes on Personal Income Degree Doctor of Philosophy Department Economics, Department of Advisory Committee
Advisor Name Title Randall Holcombe Committee Chair Thomas McCaleb Committee Member Thomas Zuehlke Committee Member Charles Barrileaux University Representative Keywords
- Taxable Income
- Tax Effects
Date of Defense 2009-10-12 Availability unrestricted AbstractThis dissertation is a contribution to the taxable income literature. This literature attempts to assess how personal income changes when personal income taxes do. The pioneering studies of Lindsay (1987) and Feldstein (1995) argued that taxpayers may respond to tax changes by working less hard (not necessarily fewer hours), through evasion, and making a smart use of the tax code. Their main conclusion is that the income elasticity to tax changes is much higher than that suggested by the labor literature (above 1).
Later studies attempted to improve Lindsay and Feldstein’s estimates arguing that income retiming, income shifting, and an unrelated widening of the income were yielding upward biased estimates. Papers such as Gruber and Saez (2002) and Caroll (1998) estimated elasticity in the vicinity of 0.4. Auten Goolsbee is skeptical to the magnitude of this elasticity and suggests the “high elasticities” found by this literature is related with the outlier condition of the eighties (Goolsbee, 1999). Furthermore, Goolsbee (2000) claimed that much of the income response from top taxpayers is due to income retiming, not to structural responses. Saez (2004) analyzes four decades from 1960 to 2000 and concludes than only high-income people would be responsive to tax changes and this would be true only after 1980 with no income response for the Kennedy’s tax cuts.
In this dissertation we take the contributions of the taxable income literature in the sense that personal income as a whole is a good indicator to survey how tax changes may affect taxpayers’ behavior. Nevertheless, we propose two important changes to the underlined model used by this literature.
First, this literature assumes that taxes affect only the individuals on whom the statutory tax is levied. Furthermore, this literature assumes that those receiving higher tax changes should be more responsive. This second assumption allows them to use the diff-in-diff method and income share analysis. These assumptions are not supported by the incidence literature which points out that the tax burden is borne by taxpayers according to the elasticity of the suppliers and demanders. Thus, we argue that using its underlined model the taxable income literature is not able to properly capture structural responses to tax changes but it is able to capture non-structural responses such as income retiming, income shifting, evasion, fringe benefits, and charitable contributions and so on. These non-structural responses are just income transferring from some individuals to others but they do not necessarily have income creation effects. Structural responses have income creation effects. Chapter 4 uses more that 40 years of data and shows that income of high-income taxpayers is affected both by the rates they face and by the rates faced by non-high-income taxpayers. The income of high-income taxpayers rises when they face lower tax rates, but also rises in response to lower tax rates imposed on non-high-income taxpayers. While high-income responses to own statutory tax changes may be explained – at least partially – by their making a “smart use of the tax code,” high-income responses to tax changes on non-high income individuals indicate the presence of structural effects of tax changes. This evidence rejects Goolsbees (2000) claim that taxes are just a smart use of the tax code and Saez (2004) claim that high income individual respond to tax changes only after 1980.
Second, another assumption of the underlined model is that tax changes affect the level of income but not the rate of income growth. While the Solow model may back such an assumption, later research such as that of Kenneth Arrow, Douglas North, Robert Lucas, Robert Barro seems to show that institution, especially government, may affect the rate of income growth. Douglas North argues that the permanent income growth shows by countries like the USA, is the result of the implementation of property rights protecting and rewarding individuals’ innovation. From a microeconomics perspective individuals may see taxes as a factor working in the opposite direction as property right. In this sense, having a tax of 100% is equivalent to not having property rights. More generally speaking, the higher the tax the less incentive have individuals to innovate and this way the level of the tax may affect the rate of income growth. In chapter 5, we modified the critical assumptions made by the taxable income literature presented above and we provide evidence that taxpayers as a whole are responsive to tax changes and not only the top1% as Saez (2004) argued. We find a negative correlation between income marginal tax rates and adjusted gross income (AGI) growth. The empirical work in this chapter estimates that the elasticity of AGI growth to marginal income tax rate is -0.4. The consequence of this elasticity for public policy purposes is remarkable and suggests that average marginal taxes around 26% (such as the seventies) yield less revenue in the long run for the government than taxes around 23% (as those of the sixties).
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