5.4 The Distribution of the Tax Rate Instruments
Each of the three methods yields a predicted tax rate in 2002 for each taxpayer. For the standard and expected income instruments these are represented by the four statutory tax rates in the 2002 schedule. For the expected tax rate instrument, being an income-weighted average, in principle these may take any number of possible values between the lowest and highest statutory rates.
- Figure 2: Distribution of Tax Rate Instruments
The top half of Figure 2 shows the percentage of taxable income associated with taxpayers facing the respective marginal rates based on the first two instrumental variable measures. This 'taxable income share’ distribution is more relevant for behavioural responses than the equivalent share of taxpayers. As can be seen in Figure 2, the share of income facing the four different rates is quite similar. However, whereas the standard instrument produces an increasing share of income across the 21, 33 and 39 per cent rates, the reverse is true for the expected income tax instrument. Taxpayers facing the 39 per cent marginal rate (based on these instruments) account for almost 40 per cent of taxable income using the standard instrument, but the corresponding proportion is less than 20 per cent based on the expected income instrument. This probably reflects the ability of the expected income instrument to capture the likelihood that some of those observed (pre-reform) in the top tax bracket, experience an income fall that pushes them into a lower tax bracket. The standard instrument cannot accommodate this aspect.
The lower half of Figure 2 shows the equivalent histogram for the expected tax rate instrument. Both the share of taxpayers, and the share of taxable income, are included for comparison. In each case the expected tax rate shown on the horizontal axis, for example, 24 and 25 per cent, represents the share of income, or taxpayers, having a tax rate instrument lying between 24.00 and 24.99 per cent, 25.00 and 25.99 per cent and so on. The resulting range of expected tax rates is narrower than for the other two instruments, lying between rates of 24 and 34. This reflects the weighting process across the probability distribution of possible tax rates with a minimum and maximum rate respectively of 15 and 39 per cent.