Personal Income Taxation and Household Behavior

June 16-18, 2014
Christian Keuschnigg, IHS and University St. Gallen, and Roger Gordon, University of California at San Diego, Organizers

Richard Blundell, University College London and Institute for Fiscal Studies; Monica Costa Dias and Jonathan Shaw, Institute for Fiscal Studies; and Costas Meghir, Yale University and NBER

Female Labor Supply, Human Capital, and Welfare Reform (NBER Working Paper 19007)

Blundell, Costa Dias, Meghir, and Shaw consider the impact of tax credits and income support programs on female education choice, employment, hours, and human capital accumulation over the lifecycle. They thus analyze both the short-run incentive effects and the longer run implications of such programs. By allowing for risk aversion and savings, the authors are also able to quantify the insurance value of alternative programs. They find important incentive effects on education choice and labor supply, with single mothers having the most elastic labor supply. Returns to labor market experience are found to be substantial, but only for full-time employment and especially for women with more than basic formal education. For those with lower education, the welfare programs are shown to have substantial insurance value. Based on the model, marginal increases to tax credits would be preferred to equally costly increases in income support and to tax cuts, except by those in the highest education group.

Robert McClelland and Shannon Mok, Congressional Budget Office, and Kevin Pierce, Internal Revenue Service

Labor Force Participation Elasticities of Women and Secondary Earners within Married Couples

Labor supply elasticities are often used to evaluate the effect of changes in tax rates on the total hours worked in the economy. Married women have traditionally been assumed to be the so-called "marginal" workers in their households in the sense of having larger labor supply elasticities. However, those elasticities have fallen sharply in recent decades - a decline that has been attributed to greater participation rates and more generally increased career orientation among married women. Indeed, a growing share of wives earn more than their husbands, raising the question as to whether a person's sex or relative earnings is the relevant factor determining the sensitivity of participation to wage and tax rates. In this paper, McClelland, Mok, and Pierce use administrative data to examine whether the woman or the lower-earning spouse is the marginal worker. They present descriptive evidence on the share of women who are the primary earner and the frequency of transitions into and out of employment by sex and relative earnings. They find that the lower-earning spouse, not the woman, is more likely to start and stop working. The authors then model an individual's work decision using a dynamic probit model to isolate the labor supply response to changes in tax rates. They estimate that the participation elasticity with respect to the net-of-tax rate of the secondary earner - the spouse who typically has lower earnings - is similar to that for women, though both of these overall elasticities are small. Participation elasticities with respect to income for both women and secondary earners are effectively zero. The authors' estimates are robust to several alternative models, including specifications of secondary earner.

Aspen Gorry, Utah State University; Kevin Hassett and Aparna Mathur, American Enterprise Institute; and Glenn Hubbard, Columbia University and NBER

The Elasticity of Deferred Income with respect to Marginal Income Tax Rates

A substantial body of theoretical and empirical analysis of time-varying income tax rates focuses on the response of taxable income to changes in the tax rate. Given the increasing use of stock options in executive compensation, Gorry, Hassett, Hubbard, and Mathur document that income deferral is an important margin of adjustment in response to tax rate changes. The option to defer income changes the welfare effect of taxation as it allows individuals to shift income into the future, reducing their overall tax burden. To account for this option in the empirical analysis, the authors explore both realization and deferral by estimating the elasticity of deferred income. Their empirical results suggest a large impact of taxes on income timing with magnitude of the elasticity of deferred income that is greater than one.

Jon Bakija and William Gentry, Williams College

Capital Gains Taxes and Realizations: Evidence from a Long Panel of State-Level Data

Bakija and Gentry estimate how capital gains realizations respond to marginal tax rates on capital gains using a panel of aggregate data for U.S. states for the years 1957 through 2007. In specifications controlling for state fixed effects and year fixed effects, where identification comes from difference-in-differences variation in effective state marginal tax rates, the authors' point estimate of the elasticity of capital gains realizations with respect to the marginal tax rate is -0.6 with a standard error of 0.2. This point estimate suggests a significant and policy-relevant responsiveness of capital gains realizations to incentives, implying that the revenue gain from a capital gains tax increase would be around 60 percent smaller than it would have been in the absence of the behavioral response, and is based on a relatively more convincing identification strategy than has been used in the previous literature. When the authors remove state and/or year fixed effects, relying on cross-state variation in tax rates and/or federal time-series variation tax rates for identification, their estimates of the elasticity of capital gains to the marginal tax rate are larger in absolute value, but also potentially subject to greater concerns about omitted variable bias.

Philipp Dörrenberg, Andreas Peichl, and Sebastian Siegloch, ZEW and IZA

How Responsive Are Deductions to Tax Rate Changes?

While the large literature on the elasticity of taxable income (ETI) suggests that taxpayers respond to tax rate changes, evidence on the adjustment channels along which these responses occur is relatively scarce. In this paper, Dörrenberg, Peichl, and Siegloch explore whether tax deductions are responsive to tax reforms and hence constitute one of these adjustment channels. The authors rely on rich German panel data from administrative tax records that includes detailed information on all income-tax-relevant parameters including all available tax deductions, and exploit several tax reforms that were implemented in Germany between 2001 and 2008. Their findings suggest an overall ETI of 0.15 for Germany and the authors provide evidence that this overall response is partly attributable to deduction adjustments. Their findings offer insights into designing efficient tax systems that close the most responsive deduction possibilities and thus trigger fewer behavioral adjustments.

Dominika Langenmayr, University of Munich

Voluntary Disclosure of Evaded Taxes - Increasing Revenues, or Increasing Incentives to Evade?

Many countries levy lower fines on tax-evading individuals when they voluntarily disclose the tax evasion they committed. models such voluntary disclosure mechanisms theoretically and shows that while such mechanisms increase the incentive to evade taxes, they nevertheless increase tax revenues net of administrative costs. She then tests these theoretical predictions in two separate empirical analyses. First, she confirms that voluntary disclosure mechanisms increase tax evasion using the introduction of the 2009 offshore voluntary disclosure program in the United States for identification. Second, she quantifies the additional tax revenues of voluntary disclosures by considering how some state-level governments in Germany bought whistleblower data from foreign bank employees, thereby increasing the probability of detection and the use of voluntary disclosures.

John Beshears, David Laibson, and Brigitte Madrian, Harvard University and NBER, and James Choi, Yale University and NBER

Does Front-Loading Taxation Increase Savings? Evidence from Roth 401(k) Introductions

Can governments increase private savings by taxing savings up front instead of in retirement? Roth 401(k) contributions are not tax-deductible in the contribution year, but they are untaxed upon withdrawal in retirement. The more common before-tax 401(k) contribution is tax-deductible in the contribution year, but both principal and earnings are taxed upon withdrawal. Using administrative data from 12 companies that added a Roth option between 2006 and 2010, Beshears, Choi, Laibson, and Madrian find no evidence that total 401(k) contribution rates differ between employees hired before versus after the Roth introduction, which means that the amount of retirement consumption being purchased by 401(k) contributions increases after the Roth introduction. A survey experiment suggests two behavioral factors play a role in the unresponsiveness of contribution rates: 1, employee confusion about or neglect of the tax properties of Roth balances; and 2, partition dependence.

Jeffrey Brown, University of Illinois at Urbana-Champaign and NBER, James Poterba, MIT and NBER, and David Richardson, TIAA-CREF Institute and NBER

Do Required Minimum Distributions Constrain Household Behavior? The Effect of the 2009 Holiday on Retirement Savings Plan Distributions

Brown, Poterba, and Richardson investigate how the 2009 one-time suspension of the Required Minimum Distribution (RMD) rules associated with qualified retirement plans affected plan distributions at TIAA-CREF, a large retirement services provider. Using panel data, the authors find that roughly one-third of the retirement plan participants who were over the age of 70½ in 2008 and who were therefore affected by the minimum distribution rules discontinued their distributions in 2009. The results also show relatively small differences in the suspension probability between those who had 2008 distributions equal to the RMD amount and who might therefore be classified as facing a binding RMD constraint, and those who were taking distributions in excess of the RMD amount before the distribution holiday. The probability of suspension declines with age and rises with economic resources. These findings provide some insight on the revenue consequences of changing RMD rules, and they also raise questions about the role of various behavioral considerations, such as inertia, in modeling distribution behavior.

Jarkko Harju, Government Institute for Economic Research, and Tuomas Matikka, Government Institute for Economic Research

The Elasticity of Taxable Income and Income-shifting: What is "Real" and What is Not?

Previous literature shows that income taxation significantly affects the behavior of high-income earners and business owners. However, it is still unclear how much of the response is attributable to changes in effort and other real economic activity, and how much is caused by tax avoidance and tax evasion. This distinction is important because it affects welfare implications and policy recommendations. In this paper, Harju and Matikka distinguish between real responses and tax-motivated income-shifting between tax bases. Their empirical example shows that income-shifting accounts for over two-thirds of the overall elasticity of taxable dividend income among Finnish business owners. As the shifted income is also taxed, this halves the marginal excess burden compared to the standard model in which the overall elasticity defines the welfare loss. However, in addition to income shifting, the authors find that dividend taxation significantly affects the real behavior of the owners.

Luzi Hail and Stephanie Sikes, University of Pennsylvania, and Clare Wang, Northwestern University

Cross-Country Evidence on the Relation between Capital-Gains Taxes, Risk, and Expected Returns

Hail, Sikes, and Wang empirically examine the prediction in Sikes and Verrecchia (2012) that the relation between capital gains tax rates and expected rates of return varies in the cross-section and over time with firm risk and market risk. Specifically, the authors test whether the general positive relation between expected returns and the capital gains tax rate becomes weaker or even reverses when: 1, a firm's systematic risk is high; 2, the market risk premium is high; or 3, the risk-free rate is low. Using an international panel from 27 countries over the period 1990 to 2004, the authors find evidence supporting these predictions. The results are particularly pronounced in countries with substantive changes in tax rates, more trust in government institutions, less integrated and less liquid capital markets, and lower institutional ownership as well as around substantive increases and decreases in the three risk proxies. The authors corroborate their findings in a single country setting using the 1978, 1997, and 2003 changes to the capital gains tax rate in the United States as events. Their results underscore the importance of macroeconomic and firm-specific factors in determining the effect of capital gains taxes on expected returns, and suggest that tax rate changes can sometimes have opposite valuation implications than what policymakers have in mind.

Annette Alstadsæter, University of Oslo, and Martin Jacob, Otto Beisheim School of Management

Do Dividend Taxes Affect Corporate Investment?

Alstadsæter and Jacob test whether dividend taxes affect corporate investments. They exploit Sweden's 2006 dividend tax cut of 10 percentage points for closely held corporations and 5 percentage points for widely held corporations. Using rich administrative panel data and triple-difference estimators, they find that this dividend tax cut affects allocation of corporate investment. Cash-constrained firms increase investment after the dividend tax cut relative to cash-rich firms. Reallocation is stronger among closely held firms that experience a larger tax cut. This result is explained by higher equity in cash-constrained firms and by higher dividends in cash-rich firms after the tax cut. The heterogeneous investment responses imply that the dividend tax cut raises efficiency by improving allocation of investment.

Peter Egger and Katharina Erhardt, ETH Zürich, and Christian Keuschnigg

Personal Income Taxes, Corporate Profit Taxes and the Heterogeneous Tax Sensitivity of Firm-Level Investments

Firms are heterogeneous in size, productivity, ownership concentration, governance, financial structure, and other dimensions. Egger, Erhardt, and Keuschnigg introduce a stylized theoretical framework to account for such differences and to explain the heterogeneous tax sensitivity of firm-level investments. They econometrically test the theoretical predictions, taking account of selection of firms into different classes. They find important differences in the tax sensitivity of investment of small entrepreneurial and larger managerial firms in different financial regimes that are largely in line with theoretical results.

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