Emmanuel Saez on Taxes and Elasticity

What with Emmanuel Saez winning prestigious awards and all, I thought the world might like to know about some of his policy-relevant research. Thus, a consideration of “The Elasticity of Taxable Income with Respect to Marginal Tax Rates: A Critical Review” with Joel Slemrod and Seth Giertz. The paper is substantially concerned with methodological issues many of which are over my head, so I’ll leave that aside. But they reach the following conclusions.

First, they report that there’s little support for the idea that increases in marginal tax rates harm the economy but reducing people’s incentives to work. Studies, in other words, show low levels of labor supply elasticity with respect to marginal tax rates. But they observe that other forms of economic distortion are possible. And you can get a comprehensive look at them by looking at the comprehensive elasticity of taxable income.

In the US context, there seems to be a fair amount of such elasticity. And the elasticity is concentrated among taxpayers who itemize their deductions, and especially among high-income taxpayers. In part this reflects people shifting their income in time (for example, people filling out 1992 tax forms in early 1993 responded to Bill Clinton’s election in apparent anticipation of higher taxes in the near future by shifting income into 1992) and in part it reflects deduction-seeking behavior. It also seems to be the case that in countries where fewer deductions are available (Canada, for example) elasticity is lower.

The upshot of this is mostly that this entire line of inquiry is not quite as promising for policy analysis as it once appeared (“One attraction of the ETI concept—that it is a sufficient statistic for welfare analysis and therefore one need not inquire into the anatomy of behavioral response—has proven to be overstated”) since the consequences of a change in ETI for welfare is going to depend on where the money goes.

One fairly clear policy implication of this for the modern-day American context, however, is that if you’re trying to raise some extra revenue from wealthy taxpayers it’s probably better to do that by curbing deductions than by raising rates. Among other things, curbing deductions will make it easier to raise rates in an efficient manner down the road. Similarly, there seems to be a fair chance that growth could be boosted significantly by a broad tax reform that eliminates loopholes and lowers rates.