Estimating the Elasticity of Taxable Income in New Zealand

type="main" xml:id="ecor12151-abs-0001"> This paper produces regression estimates of the elasticity of taxable income in New Zealand using two new instruments applied to a substantial tax reform ‘experiment’. Instrumental variable methods are required to deal with endogeneity of the tax rate and taxable income in a non-linear tax structure. However, in the New Zealand context, the ‘standard’ regression instrument is found to be unable to accommodate the substantial observed exogenous (non-tax-induced) changes in taxable income. Two new tax rate instruments are proposed, which use information on taxable income dynamics, for a panel of taxpayers over a period that involves no tax changes, to derive taxpayers’ counterfactual post-reform incomes and tax rates expected in the absence of reform. The two instruments respectively measure, for each taxpayer, the tax rate associated with expected mean income, and the expected tax rate associated with the individual's expected conditional distribution of income. Applying these instruments to the 2001 New Zealand tax changes yields plausible estimates of the elasticity of taxable income around 0.5–0.7. Elasticities are found to be substantially higher for taxpayers with non-wage-and-salary income compared with wage and salary only taxpayers. Results also confirm that non-wage-and-salary income was especially responsive to the tax changes.

[1]  N. Gemmell,et al.  The Tax Gap: A Methodological Review , 2012 .

[2]  J. Creedy,et al.  Measuring revenue responses to tax rate changes in multi-rate income tax systems: behavioural and structural factors , 2012 .

[3]  J. Creedy,et al.  Revenue-Maximising Elasticities of Taxable Income in Multi-Rate Income Tax Structures , 2012 .

[4]  J. Creedy,et al.  Regression Estimates of the Elasticity of Taxable Income and the Choice of Instrument , 2012 .

[5]  Alastair Thomas.  The elasticity of taxable income in New Zealand: Evidence from the 1986 tax reform , 2012 .

[6]  R. Barro,et al.  Average Marginal Income Tax Rates in New Zealand, 1907-2009 , 2012 .

[7]  I. Lurie,et al.  THE EFFECT OF RECENT TAX CHANGES ON TAX-PREFERRED SAVING BEHAVIOR , 2012, National Tax Journal.

[8]  B. Holmlund,et al.  Estimating Dynamic Income Responses to Tax Reform , 2011 .

[9]  Guyonne Kalb,et al.  Measuring Welfare Changes in Behavioural Microsimulation Modelling: Accounting for the Random Utility Component , 2011 .

[10]  J. Creedy,et al.  Decomposing Inequality and Social Welfare Changes: The Use of Alternative Welfare Metrics , 2011 .

[11]  Seth H. Giertz.  The Elasticity of Taxable Income During the 1990s: New Estimates and Sensitivity Analyses , 2010 .

[12]  B. Heim.  The effect of recent tax changes on taxable income: Evidence from a new panel of tax returns , 2009 .

[13]  Emmanuel Saez,et al.  The Elasticity of Taxable Income with Respect to Marginal Tax Rates: A Critical Review , 2009 .

[14]  S. Blomquist,et al.  Hourly Wage Rate and Taxable Labor Income Responsiveness to Changes in Marginal Tax Rates , 2009, SSRN Electronic Journal.

[15]  R. Moffitt,et al.  Trends in the Transitory Variance of Male Earnings , 2008, The Journal of Human Resources.

[16]  Gerald E. Auten,et al.  The 2001 and 2003 Tax Rate Reductions: An Overview and Estimate of the Taxable Income Response , 2008, National Tax Journal.

[17]  C. Meghir,et al.  Labour Supply and Taxes Labour Supply and Taxation Labour Supply and Taxes * , 2022 .

[18]  A. Leigh,et al.  Top Incomes in New Zealand 1921-2005: Understanding the Effects of Marginal Tax Rates, Migration Threat, and the Macroeconomy , 2008 .

[19]  Raj Chetty.  Is the Taxable Income Elasticity Sufficient to Calculate Deadweight Loss? The Implications of Evasion and Avoidance , 2008 .

[20]  Seth H. Giertz.  The Elasticity of Taxable Income over the 1980s and 1990s , 2007, National Tax Journal.

[21]  J. Creedy,et al.  Comparing Welfare Change Measures with Income Change Measures in Behavioural Policy Simulations , 2007 .

[22]  J. Creedy,et al.  Tax Policy Design and Behavioural Microsimulation Modelling , 2007 .

[23]  J. Creedy,et al.  Behavioural Microsimulation Modelling for Tax Policy Analysis in Australia: Experience and Prospects , 2005 .

[24]  Seth H. Giertz.  Recent Literature on Taxable-Income Elasticities , 2004 .

[25]  Åsa Hansson,et al.  Taxpayers' responsiveness to tax rate changes and implications for the cost of taxation in Sweden , 2004 .

[26]  Emmanuel Saez.  Reported Incomes and Marginal Tax Rates, 1960-2000: Evidence and Policy Implications , 2004, Tax Policy and the Economy.

[27]  J. Selen.  Taxable income responses to tax changes - a panel analysis of the 1990/91 Swedish reform* , 2002 .

[28]  T. Thoresen,et al.  Income Responses to Tax Changes—Evidence from the Norwegian Tax Reform , 2001, National tax journal.

[29]  M. Veall,et al.  The Effect of Marginal Tax Rates on Taxable Income: A Panel Study of the 1988 Tax Flattening in Canada , 2001 .

[30]  I. Preston.  Measuring welfare changes and tax burdens. , 2000 .

[31]  Emmanuel Saez,et al.  The Elasticity of Taxable Income: Evidence and Implications , 2000 .

[32]  Gerald E. Auten,et al.  The Effect of Income Taxes on Household Income , 1999, Review of Economics and Statistics.

[33]  Austan Goolsbee.  EVIDENCE ON THE HIGH-INCOME LAFFER CURVE FROM SIX DECADES OF TAX REFORM , 1999 .

[34]  Emmanuel Saez.  The Effect of Marginal Tax Rates on Income: A Panel Study of 'Bracket Creep' , 2003 .

[35]  J. Creedy.  Measuring welfare changes and tax burdens , 1998 .

[36]  R. Moffitt,et al.  Taxation and the Labor Supply: Decisions of the Affluent , 1998 .

[37]  John Creedy,et al.  The Dynamics of Inequality and Poverty: Comparing Income Distributions , 1998 .

[38]  M. Feldstein.  Tax Avoidance and the Deadweight Loss of the Income Tax , 1995, Review of Economics and Statistics.

[39]  J. Creedy.  Statics and Dynamics of Income Distribution: An Introductory Survey , 1994 .

[40]  M. Arellano,et al.  Some Tests of Specification for Panel Data: Monte Carlo Evidence and an Application to Employment Equations , 1991 .

[41]  Lawrence B. Lindsey.  Individual taxpayer response to tax cuts: 1982-1984: With implications for the revenue maximizing tax rate , 1987 .

[42]  J. Creedy.  Dynamics of income distribution , 1986 .

[43]  C. Weber.  The Fixed-Bracket Average Treatment Effect: A Constructive Alternative to LATE Analysis for Tax Policy , 2012 .

[44]  Jorge Onrubia Fernández José Félix Sanz Sanz.  Reported Taxable Income and Marginal Tax Rates: Evidence for Spain Based on the Fiscal Drag , 2009 .

[45]  J. Creedy.  The Elasticity of Taxable Income , 2009 .

[46]  Gov,et al.  Working Paper Series Congressional Budget Office Taxable Income Responses to 1990s Tax Acts: Further Explorations , 2022 .

[47]  M. Feldstein,et al.  Evidence on the High-Income Laffer Curve from Six Decades of Tax Reform , 1999 .

[48]  A. Grimes,et al.  Economic Reform in New Zealand 1984-95: The Pursuit of Efficiency , 1996 .

[49]  Johan A. Lybeck,et al.  The statics and dynamics of income , 1980 .

[50]  J. Paul Getty,et al.  How to Be Rich , 1965 .

[51]  Do Taxpayers Really Respond to Changes in Tax Rates ? Evidence from the 1993 Tax Act , 2022 .