The elasticity of taxable income and income-shifting between tax bases: what is “real” and what is not?

Jarkko Harju and Tuomas Matikka

No 1313, Working Papers from Oxford University Centre for Business Taxation

Abstract: Previous literature shows that income taxation especially affects the behaviour of business owners and entrepreneurs. However, it is still unclear how much of the response is due to changes in effort and other real economic activity, and how much is due to tax avoidance and tax evasion. This is important because the nature of the response largely affects the welfare implications and policy recommendations. In this paper we distinguish between real responses and tax-motivated income- shifting between tax bases using the widely-applied elasticity of taxable income (ETI) framework. We use extensive register-based panel data on both the owner and firm-level, which enable us to carefully distinguish between real effects and income-shifting among the owners of privately held corporations in Finland. Our results show that income-shifting accounts for over two thirds of the overall ETI. As the shifted income is also taxed, this significantly decreases the marginal excess burden of income taxation compared to the standard model in which the overall ETI defines the welfare loss. However, in addition to income-shifting effects, we find that dividend taxation significantly affects the real behaviour of the owners.

Keywords: Personal income taxation; Elasticity of taxable income; Business owners; Tax avoidance (search for similar items in EconPapers)
JEL-codes: H24 H25 H32 (search for similar items in EconPapers)
Date: 2013
New Economics Papers: this item is included in nep-acc, nep-iue, nep-pbe and nep-pub
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (11)

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