Elasticity of Taxable Income: An Introduction and Some Basic Analytics

Abstract

This paper provides an introduction to the concept of the elasticity of taxable income with respect to the net-of-tax rate. This elasticity aims to capture all potential responses to income taxation in a single elasticity measure, without the need to specify the nature of the various adjustment processes involved or consider the details of tax regulations. These adjustments include, as well as labour supply changes, income shifting between sources which are taxed at different rates, and tax evasion through non-declaration of income. The use of such a ‘reduced form’ approach has proved to be very attractive. The elasticity of taxable income has the added attraction that, under certain assumptions, it is sufficient to obtain a measure of the excess burden of income taxation. Emphasis is placed on the assumptions behind the approach.