Reforms and Quasi-Experiments: Empirical Research … · German data supports Mankiw (Buettner and Kauder, 2015) BUETTNER (FAU) DWL of Taxes NOeG Linz ’17 3 / 48. Revenue Estimates

Reforms and Quasi-Experiments:Empirical Research on the Deadweight Loss of Taxes

THIESS BUETTNER

Univ. of Erlangen-Nuernberg

Annual Meeting of the Austrian Economic Association 2017

BUETTNER (FAU) DWL of Taxes NOeG Linz ’17 1 / 48

Tax Ratio (OECD average) on Record Level

Total tax revenue as % of GDP, 1965-2014. Source: OECD Revenue Statistics (2017).


Taxation as a Challenge

• Can this high level of tax revenues be sustained?

• How large is the deadweight loss?

• Can we reduce the deadweight loss?


Policy Debate on Tax Cuts

• Political narrative: Large tax cuts could release so much economicactivity that revenue remains constant.

• “A reasonable rule of thumb, in my judgment, is that about one-thirdof the cost of tax cuts is recouped via faster economic growth.(NYT quote of Greg Mankiw, April, 2017)

• German data supports Mankiw (Buettner and Kauder, 2015)


Revenue Estimates for German Tax Reforms

Reform estimate in % of revenues, Buettner and Kauder (2015).


Revenue Estimates and Forecast Error

• Government produces static revenue estimates of tax reforms

• Estimates are added in revenue forecast for current year

• Results show that revenue estimate overpredicts revenue effects

• Tax cut by 1 Euro results in a revenue forecast error of 32 cents

• Results for individual taxes?


Revenue Estimates and Forecast Error

Source: Buettner and Kauder (2015).

��


Agenda

1. Deadweight loss and revenue effects

2. Methodological advances using individual tax files

2.1. Tax reforms

2.2. Kinks and Notches

3. Disassembly of tax-payer response

4. Implications for tax policy


1. Deadweight Loss (DWL) Defined

• Ramsey tax problem with labor t and lump-sum taxes T

L = V (t,T ) + λ [tz + T − R0]

• Revenue substitution using labor taxes yields marginal deadweight loss

MDWL = t∂zc

∂(1− t)

• By linear approximation (Harberger, 1964)

DWL ' 1

2t2 ∂zc

∂(1− t)


1. The Harberger Triangle

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6

z

compensatedlabor supply

e

DWL ' −12 t

2 ∂zc

∂(1−t)

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1− t

B

F

C

E

GBUETTNER (FAU) DWL of Taxes NOeG Linz ’17 9 / 48

1. Deadweight Loss (DWL) and Revenue Effects

• Tax revenue from income tax R = tz

• Tax rate has “mechanical” and tax-base effects

∂R

∂t= z︸︷︷︸

dM

− t∂z

∂(1− t)︸︷︷︸dB

• MDWL: (compensated) effect on tax base net of mechanical effect.


1. Deadweight Loss (DWL) with Multiple Margins

• Tax revenue from income tax R = t (z − s)

• Resource cost of avoidance κ (s), with κ′ > 0, κ′′ > 0

• Optimal avoidance κ′ (s∗) = t

MDWL = t∂zc

∂(1− t)+ t

∂s∗

∂t

∂R

∂t= z − s︸︷︷︸

dM

−[t

∂z

∂(1− t)+ t

∂s∗

∂t

]︸︷︷︸

dB

• ETB (tdB/ (z − s)) or ETI (( 1−tt )ETB) reveal welfare loss


1. ETI as Sufficient Statistic

• Reduced-form effect of tax-rate on revenues

• Multiple margins (Feldstein, 1999)

• Aggregation over heterogenous responses (Chetty, 2009)


2. Methodological Advances

Empirical literature on revenue effects exploits

• Tax reforms

• Discontinuities in the tax code

• Combinations


2.1. Tax Reform Studies

• Panel data of individual tax returns (e.g., Feldstein, 1995; Auten andCaroll, 1999; Gruber and Saez, 2002; Kopczuk, 2005; Weber, 2014)

• E.g., Sweden (Blomquist and Selin, 2010; Gelber, 2014), Germany(Doerrenberg, Peichl, Siegloch, 2015)

• Results point to larger elasticities than found by labor supply literature

• ... but differ substantially even for same countries/reforms


2.1. Tax Reform Studies - US Studies

MEB: Marginal deadweight loss relative to marginal revenues at t = 30%

• Feldstein (1995), ETI of 1.10(3.05)– implying MEB of 1.9 (at least)

• Auten and Carroll (1999), ETI of 0.57– implying MEB of 1.3

• Gruber and Saez (2002), ETI of 0.4– implying MEB of 1.2

• Weber (2014), ETI of 1.046– implying MEB of 1.8


2.1. Tax Reform Studies - Methodological Challenges

• Studies exploit tax variation at individual level

• Tax variation is contaminated by preferences (Saez, 2010)

• Tax burden is instrumented based on taxable income pre-reform

• Instrument captures mean reversion effects

• Rising income inequality conflicts with common trend assumption


2.2. Discontinuity Studies

• Tax nonlinearities due to direct progression and welfare

Kink (Paetzold, 2017) Notch (Tazhitdinova, 2016)


2.2. Discontinuity Studies

• Traditional approach: local linearization (e.g., Hausman 1981,MaCurdy, Green, and Paasch, 1990)

• Recent literature exploits discontinuities as a source of identification

• Kinks: e.g., Saez (2010); Chetty, Friedman, Olson, Pistaferri (2011)

• Notches: e.g., Kleven and Waasem (2013); Kopczuk and Munroe(2015)


2.2. Kink-Point Analysis: Theory

• Tax payers differ by ability n with density h(n)

U (c , z) = c − ψ (z , n)

with ψz > 0 and ψzn < 0

• Nonlinear tax system

T =

{tz

tz0 + tH (z − z0)

• Bunching z0 reveals labor supply elasticity (Saez, 2010)


2.2. Kink-Point Analysis: Illustration

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6

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e

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zHBUETTNER (FAU) DWL of Taxes NOeG Linz ’17 20 / 48

2.2. Kink Points: From Bunching to ETI

• Total amount of bunching B =∫ z0 + zH−z0

z0h (n) dz = (zH − z0) h (n0)

• Labor supply response of “marginal buncher” zH−z0z0

=(tH−t1−t

)ETI c

• With B, z0 and tax rates known strength of bunching reveals ETI c

• ETI c captures compensated elasticity (for small tH − t)

• Focus on intensive margin response


2.2. Kink Points: Marginal Revenue

• Tax revenue

R = tL

(∫ nL

zh (n) dn +

∫nL

z0h (n) dn

)+ tH

∫nH

(z − z0) h (n) dn

• marginal increase in tH gives

∂R

∂tH=

∫nH

(z − z0) h (n) dn︸︷︷︸dM

−tH∫nH

∂z

∂(1− tH)h (n) dn︸︷︷︸

dB

• MDWL equal to (compensated) effect on the tax base net ofmechanical effect


2.2. Kink-Point Analysis: Saez (2010)

Source: Saez (2010), Single Tax Filers, 1988-2020


2.2. Kink-Point Analysis: Schaechtele (2017)

Source: Schaechtele (2017), Tax filers 30-59, Singles, FDZ der Statistischen Aemter desBundes und der Laender, Lohn- und Einkommensteuerstatistik 2007


2.2. Results of Kink-Point Analysis

• Bunching at first tax bracket of the income tax, where ETI is 0.191

• No effect for higher incomes/tax bracket

• Small effects confirmed for Denmark (Chetty et al., 2011), where ETIis 0.01 (all wage earners, top bracket)

• Sweden (Bastani and Selin, 2014) with ETI of 0.004

• Austria (Paetzold, 2017) with ETI of 0.1

• Germany (Schaechtele, 2017) with ETI 0.06 at first bracket

• Netherlands (Dekker and Strohmaier, 2015) with ETI of 0.02


2.2. Kink-Point Analysis: Varying Effects

Chetty et al. (2011) note that bunching gets stronger with

• higher tax differential

• number of tax payers affected

• certain occupations

→ Frictions and optimization errors may explain lack of bunching


2.2. Analysis of Notches

• Potentially (much) stronger effects

• Clearly dominated region: bunching required to avoid net-losses

• With frictions observed < structural elasticity

• Lower and upper bounds for ETI (Kleven and Waasem, 2013)

• E.g., bunching hole method: tax payers in dominated region can beused to determine share of individuals with prohibitive adjustment cost


2.2. Analysis of Notches: Illustration

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zHBUETTNER (FAU) DWL of Taxes NOeG Linz ’17 28 / 48

2.2. Analysis of Notches: Kleven and Waasem (2013)

Source: Kleven and Waasem (2013), Figure VI, Notch at 300K


2.2. Analysis of Notches: Kleven and Waasem (2013)

• Support for optimizing frictions

• Share of individuals (from counterfactual density) in dominatedregions varies between 51 and 85%

• Implied structural elasticity still small,lower bound estimate:

• self employed: from 0.05 to 0.15• wage earners: from 0.024 to 0.035


2.2. Analysis of Notches: Higher Dimensions

• Notches less common with income tax (Slemrod, 2013)

• Frequent in the context of social security, see Peichl et al. (2017)

• Roantree et al. (2017) use British data to exploit Lower EarningsLimit of National Insurance contributions

• Mass in dominated region helps to obtain structural elasticity


3. Disassembly of Tax Payer Response

Sufficient statistic only a theoretical benchmark

• Tax externalities (Saez, Slemrod, Giertz, 2012)

• Externalities from deductions (Doerrenberg, Peichl, Siegloch, 2015)

• Intertemporal effects (le Maire and Schjerning, 2013)

• Tax evasion (Chetty 2009)

• Price effects (Chetty et al. 2011)


3. Disassembly of Response: Tax Shifting

• Devereux, Liu, and Loretz (2014) consider UK corporate income tax

• Marginal corporation tax shows kinks at 10k and 300k

• Higher elasticity at lower kink (' 0.55) – consistent with US results(Patel, Seegert, Smith, 2016)

• Could reflect incentive to shift to personal income taxes

• Empirical analysis matches tax-return with accounting data

• Personal income tax kink enables to compute elasticity of the share ofincome reported as profit.


3. Disassembly of Response: Real Responses vs. Reporting

Literature shows (much) stronger bunching

• For taxable income after deductions (e.g., Saez, 2010; Paetzold, 2017)

• For self-employed (e.g. Chetty et al., 2011; Bastani and Selin, 2014,Schaechtele, 2017)

• Taxpayer- vs employer-reported wage income (Mortensen andWhitten, 2016)

• Income components that can be retained or withdrawn (le Maire andSchjerning, 2013)


3. Disassembly of Response: Tax Enforcement

• Cost function for tax avoidance κ (s;σ) influenced by tax policy andadministration

• Empirical response ∂s∗

∂t varies with σ

• ETI is not an immutable preference parameter(Slemrod and Kopczuk, 2002)

• Base broadening (Kopczuk, 2005)

• Fack and Landais (2016) using French income tax files: bunching atthe cap for donations declined considerably after a reform requiringreceipts


4. Implications for Tax Policy

• Discontinuities provide causal evidence for behavioral effects

• Wave of exciting new empirical research: clean identification

• Bunching methods increasingly applied in other policy areas

• Interest in institutional knowledge

• Yet, highly localized effects

• Data availability as a constraint

• Tax policy involves rates, bases, enforcement and administration(Slemrod and Gillitzer, 2014)


4. Implications: The Need for Integration


4. Implications: Discontinuities as Bad Tax Design

• Discontinuities simplify tax administration?

• Politicians disregard behavioral responses

• Lack of integration

• Line drawing may limit (mechanical) cost of tax expenditures

• Tax discrimination


4. Implications: Malas Notches (Lockwood, 2016)

• Tax revenue

R = tL

(∫ nL

zh (n) dn +

∫ nH

nL

z0h (n) dn

)+ tH

∫nH

zh (n) dn

• Marginal increase in tH gives

∂R

∂tH=

∫nH

zh (n)︸︷︷︸dM

−tH∫nH

∂z

∂(1− tH)h (n)︸︷︷︸

dB

− (tLz0 − tHz) h (nH)∂nH∂tH︸︷︷︸

dnH

• Marginal revenue effect includes third term – a revenue loss inaddition to the labor supply effect.

• Marginal excess burden increases


4. Implication: Discontinuities as 2nd Best Policy

• Notches may provide local incentives (Blinder and Rosen, 1985)

• E.g., incentive for labor market participation


4. Implications: Notching Participation

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z∗


4. Implication: Discontinuities as 2nd Best Policy

• Notches may provide local incentives (Blinder and Rosen, 1985)

• E.g., incentive for labor market participation

• Characteristics notches (Gillitzer, Kleven, Slemrod, 2017)

• Spatial: special economic zones

• Intertemporal: unconventional fiscal policy

• Careful empirical evaluation required


Thanks for your attention!


References (1)

• Auten, G., Carroll, R. (1999). The effect of income taxes on household income. Review ofeconomics and statistics, 81(4), 681-693.

• Bastani, S., Selin, H. (2014). Bunching and non-bunching at kink points of the Swedish taxschedule. Journal of Public Economics, 109, 36-49.

• Blomquist, S., Selin, H. (2010). Hourly wage rate and taxable labor income responsiveness tochanges in marginal tax rates. Journal of Public Economics, 94(11), 878-889.

• Blinder, A. S., Rosen, H. S. (1984). Notches. The American Economic Review, 75(4), 736-747.

• Buettner, T., Kauder, B. (2015). Political biases despite external expert participation? Anempirical analysis of tax revenue forecasts in Germany. Public Choice, 164(3-4), 287-307.

• Buhlmann, F., Loeffler, M., Peichl, A. (2017), Working Paper, ZEW Mannheim, cited inPeichl, A., Zur Rolle der klassischen Verteilungspolitik, Presentation at a Conference“Ungleichheit als wirtschaftspolitische Herausforderung” Berlin, 2017.

• Chetty, R. (2009). Is the taxable income elasticity sufficient to calculate deadweight loss? Theimplications of evasion and avoidance. American Economic Journal: Economic Policy, 1(2),31-52.

• Chetty, R., Friedman, J. N., Olsen, T., Pistaferri, L. (2011). Adjustment costs, firm responses,and micro vs. macro labor supply elasticities: Evidence from Danish tax records. The quarterlyjournal of economics, 126(2), 749-804.


References (2)

• Doerrenberg, P., Peichl, A., Siegloch, S. (2015). The elasticity of taxable income in thepresence of deduction possibilities. Journal of Public Economics.

• Dekker, V., Strohmaier, C., (2015). Bunching at Kink Points in the Dutch Tax System,Working Paper, Univ. of Hohenheim

• Devereux, M. P., Liu, L., Loretz, S. (2014). The elasticity of corporate taxable income: Newevidence from UK tax records. American Economic Journal: Economic Policy, 6(2), 19-53.

• Fack, G., Landais, C. (2016). The effect of tax enforcement on tax elasticities: Evidence fromcharitable contributions in France. Journal of Public Economics, 133, 23-40.

• Feldstein, M. (1995). The effect of marginal tax rates on taxable income: a panel study of the1986 Tax Reform Act. Journal of Political Economy, 103(3), 551-572.

• Feldstein, M. (1999). Tax avoidance and the deadweight loss of the income tax. Review ofEconomics and Statistics, 81(4), 674-680.

• Gelber, A. M. (2014). Taxation and the earnings of husbands and wives: evidence fromSweden. Review of Economics and Statistics, 96(2), 287-305.


References (3)

• Gillitzer, C., Kleven, H. J., Slemrod, J. (2017). A Characteristics Approach to OptimalTaxation: Line Drawing and Tax-Driven Product Innovation. The Scandinavian Journal ofEconomics, 119(2), 240267

• Gruber, J., Saez, E. (2002). The elasticity of taxable income: evidence and implications.Journal of public Economics, 84(1), 1-32.

• Harberger, A. C. (1964). The measurement of waste. The American Economic Review, 54(3),58-76.

• Hausman, J.A. (1981). Exact consumers surplus and deadweight loss, American EconomicReview, 71 (4), 662-676.

• Kleven, H. J., Waseem, M. (2013). Using notches to uncover optimization frictions andstructural elasticities: Theory and evidence from Pakistan. The Quarterly Journal ofEconomics, qjt004.

• Kopczuk, W. (2005). Tax bases, tax rates and the elasticity of reported income. Journal ofPublic Economics, 89(11), 2093-2119.

• Kopczuk, W., Munroe, D. (2015). Mansion Tax: The Effect of Transfer Taxes on theResidential Real Estate Market. American Economic Journal: Economic Policy, 7(2), 214-57.

• le Maire, D., and Schjerning, B. (2013). Tax bunching, income shifting and self-employment.Journal of Public Economics, 107, 118.


References (4)

• Lockwood, B., (2016). Malas Notches, Working Paper, Univ. of Warwick.

• MaCurdy, T., Green, D., Paarsch, H. (1990). Assessing empirical approaches for analyzingtaxes and labor supply. Journal of Human Resources, 415-490.

• Mortenson, J. A., Whitten, A. (2016). How sensitive are taxpayers to marginal tax rates?Evidence from income bunching in the United States. Working Paper, Georgetown University.

• Paetzold, J. (2017). How do wage earners respond to a large kink? Evidence on earnings anddeduction behavior from Austria, Working Paper, Univ. of Salzburg.

• Patel, E., Seegert, N., Smith, M. G. (2016). At a loss: The real and reporting elasticity ofcorporate taxable income, Working Paper, Univ. of Utah.

• Roantree, B., Adam, S., Browne, J., Phillips, D. (2017), Frictions and the elasticity of taxableincome: evidence from bunching at tax thresholds in the UK, Working Paper, Institute forFiscal Studies.

• Saez, E. (2010). Do taxpayers bunch at kink points? American Economic Journal: EconomicPolicy, 2(3), 180-212.

• Saez, E., Slemrod, J., Giertz, S. H. (2012). The elasticity of taxable income with respect tomarginal tax rates: A critical review. Journal of economic literature, 50(1), 3-50.

• Schaechtele, S. (2017). Quasi-experimental evidence on income tax return behavior and theelasticity of taxable income, Working Paper, Univ. of Erlangen-Nuremberg


References (5)

• Slemrod, J., Gillitzer, C. (2014). Tax systems. MIT Press.

• Slemrod, J., Kopczuk, W. (2002). The optimal elasticity of taxable income. Journal of PublicEconomics, 84(1), 91-112.

• Slemrod, J. (2013). Buenas notches: lines and notches in tax system design. eJournal of TaxResearch, 11(3), 259.

• Tazhitdinova, A. (2016), Adjust Me if I Can’t: The Effect of Firm Incentives on Labor SupplyResponses to Taxes, Working Paper, McMaster University.

• Weber, C. E. (2014). Toward obtaining a consistent estimate of the elasticity of taxableincome using difference-in-differences. Journal of Public Economics, 117, 90-103.


Documents

Reforms and Quasi-Experiments: Empirical Research … · German data supports Mankiw (Buettner and Kauder, 2015) BUETTNER (FAU) DWL of Taxes NOeG Linz ’17 3 / 48. Revenue Estimates