The Elasticity of Taxable Income, Welfare Changes and Optimal Tax Rates (WP 13/24)

Abstract

This paper provides a technical introduction to the use of the elasticity of taxable income in welfare comparisons and optimal tax discussions. It draws together, using a consistent framework and notation, a number of established results concerning marginal welfare changes and optimal taxes. Particular attention is given to the way value judgements can be specified when using this approach, and results are illustrated using the New Zealand income tax. In addition, some new results, particularly in terms of non-marginal tax changes, are presented.

Acknowledgements

I am very grateful to Martin Keene for many detailed comments, including pointing out an error in an earlier draft. I have also benefited from comments and suggestions by Simon Carey, Norman Gemmell, Jose Sanz-Sanz and Michael Freudenberg.

Disclaimer

The views, opinions, findings, and conclusions or recommendations expressed in this Working Paper are strictly those of the author. They do not necessarily reflect the views of the New Zealand Treasury or the New Zealand Government. The New Zealand Treasury and the New Zealand Government take no responsibility for any errors or omissions in, or for the correctness of, the information contained in these working papers. The paper is presented not as policy, but with a view to inform and stimulate wider debate.