A Research Seminar in Economics and Finance with Morten Håvarstein, Post-doc at the Department of Economics, University of Chicago
Morten Håvarstein, Post-doc at the Department of Economics, University of Chicago and researcher at the University of Oslo
Income and Substitution Effects of Labor Income Taxation. Co-authors: Michael Graber, Magne Mogstad, Gaute Torsvik, Ola Vestad
Wednesday, August 6 at 12.15–13.15 Room EOJ 276/277 and on Zoom
Abstract:
We study a mid-2000s reform that cut the top marginal tax rate on labor income. We first show that the conventional elasticity-of-taxable-income (ETI) estimand fails to recover a positively weighted average of individual elasticities. Correcting for this bias raises the ETI from 0.15 to 0.25. We then derive the restrictions that the estimated ETI imposes on (un)compensated earnings elasticities and on income effects, and show how they can be point- or partially identified under various (sets of) parametric assumptions. Common parametric specifications are rejected by the data. Finally, we combine the tax reform with exogenous shocks to unearned income from lottery wins to point identify income and substitution effects without parametric assumptions. The estimated compensated elasticity is more than twice the conventional ETI estimate. Taken together, our results imply that the efficiency cost of taxation can be substantial even when the conventional ETI appears small.