ELASTICITIES, TAX RATES, AND TAX REVENUE

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Abstract
This paper develops a theoretical analysis of the responsiveness of tax revenue to a change in tax rates on labor income. The model incorporates three features not simultaneously considered in previous work: a progressive change in marginal tax rates; a noncomprehensive tax base (so higher marginal rates give taxpayers incentive to convert income into nontaxable forms); and presence of a capital income tax (so if reduced current earnings leads to lower saving, future capital tax revenues will be reduced). Tax revenue elasticities and the revenue-maximizing marginal tax rate are estimated using a range of parameter values. The central finding is that tax revenue is likely to be less responsive to higher tax rates than previous estimates suggest.

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