Tax Rates and Revenue Changes: Behavioural and Structural Factors (WP 11/05)

Abstract

This paper examines the elasticity of tax revenue with respect to a marginal rate change, at both the individual and aggregate level. The roles of the elasticity of taxable income (the behavioural effect on taxable income of a tax rise) and the revenue elasticity (the structural effect on revenue of a change in taxable income) are highlighted. The revenue elasticity is the central concept in examining fiscal drag, but it has an additional role in the context of the revenue effects of tax changes when incomes respond to rate changes. Illustrations are provided using changes to the New Zealand income tax structure in the 2010 Budget. This reduced all marginal tax rates while leaving income thresholds unchanged.

Acknowledgements

The research was supported by the New Zealand Royal Society, through their Cross Departmental Research Pool scheme. We have benefited from very helpful comments on a previous version by Andrew Coleman, Chris Heady, Matt Benge and Steve Cantwell. The work actually began in an attempt to answer a question raised by Antoine Bozio.

Disclaimer

The views, opinions, findings, and conclusions or recommendations expressed in this Working Paper are strictly those of the author(s). 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.