The Elasticity of Taxable Income with Respect to Marginal Tax Rates: A Critical Review

Emmanuel Saez, University of California Berkeley and NBER
Joel Slemrod, University of Michigan and NBER
Seth H. Giertz, University of Nebraska

August 7, 2010

Second, while there is compelling U.S. evidence of strong behavioral responses to taxation at the upper end of the distribution around the main tax reform episodes since 1980, in all cases those responses fall in the first two tiers of the Slemrod (1990, 1995) hierarchy -- timing and avoidance. In contrast, there is no compelling evidence to date of real economic responses [footnote elided] to tax rates (the bottom tier in Slemrod's hierarchy) at the top of the income distribution. In the narrow perspective where the tax system is given (and abstracting from fiscal and classical externalities), the type of behavioral response is irrelevant. However, in the broader perspective where changes in tax system such as broadening the tax base, eliminating avoidance opportunities, or strengthening enforcement are possible options, the type of behavioral response becomes crucial. While such policy options may have little impact on real responses to tax rates (such as labor supply or saving behavior), they can have a major impact on responses to tax rates along the avoidance or evasion channels. In other words, if behavioral responses to taxation are large in the current tax system, the best policy response would not be to lower tax rates, but instead broaden the tax base and eliminate avoidance opportunities to lower the size of behavioral responses. Those findings also highlight the importance of the fact that the ETI is not an immutable parameter, but can be influenced by government policies. For this reason, it is likely to vary across countries and within countries over time when non-rate aspects of tax systems change.