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American Economic Journal: Economic Policy: Vol. 1 No. 2 (August 2009)

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Is the Taxable Income Elasticity Sufficient to Calculate Deadweight Loss? The Implications of Evasion and Avoidance

Article Citation

Chetty, Raj. 2009. "Is the Taxable Income Elasticity Sufficient to Calculate Deadweight Loss? The Implications of Evasion and Avoidance." American Economic Journal: Economic Policy, 1(2): 31-52.

DOI: 10.1257/pol.1.2.31

Abstract

Martin Feldstein's (1999) widely used taxable income formula for deadweight loss assumes the marginal social cost of evasion and avoidance equals the tax rate. This condition is likely to be violated in practice for two reasons. First, some of the costs of evasion and avoidance are transfers to other agents. Second, some individuals overestimate the costs of evasion and avoidance. In such situations, excess burden depends on a weighted average of the taxable income and total earned income elasticities, with the weight determined by the resource cost of sheltering income from taxation. This generalized formula implies the efficiency cost of taxing high income individuals is not necessarily large despite evidence that their reported incomes are highly sensitive to marginal tax rates. (JEL H21, H24, H26)

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Authors

Chetty, Raj (Harvard U)

JEL Classifications

H21: Taxation and Subsidies: Efficiency; Optimal Taxation
H24: Personal Income and Other Nonbusiness Taxes and Subsidies; includes inheritance and gift taxes
H26: Tax Evasion

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