Drivers of mean reversion bias in the estimation of elasticity of taxable income in an autoregressive framework

Bruno Bosco and Paolo Maranzano

No 578, Working Papers from University of Milano-Bicocca, Department of Economics

Abstract: Mean reversion, the tendency for taxpayers with unusually high or low income in one period to move towards their long-run average, is a key challenge for estimating the elasticity of taxable income (ETI), as it generates bias. We show that this bias can be characterised through the variance of the tax treatment and its covariance with windfall gains in an autoregressive model of taxable income dynamics. We further show that the bias decreases when the tax reaction of marginal treated taxpayers is weaker than that of average treated taxpayers. The paper provides analytical derivations and interpretation for these results.

Keywords: Elasticity of Taxable Income (ETI); Mean reversion and estimation bias; Variancecovariance between tax treatment assignment and windfall income shocks; Magnitude and persistence. (search for similar items in EconPapers)
JEL-codes: C22 H24 H30 (search for similar items in EconPapers)
Pages: 8
Date: 2026-06
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