Omitted-Variables Bias when Using State Tax Rates to Estimate the Tax Price Effect on Itemized Deductions

Abstract

The use of state tax rates to provide a source of variation in the tax price of deductible goods and services may lead to biased estimates if other important state characteristics are not held constant. Omitting public welfare expenditures and religious membership is found to have little effect on the estimated price elasticity of charitable contributions. In contrast, the sensitivity of interest deductions to tax rate (price) changes is overstated when state differences in housing market characteristics are ignored.