Working Paper: CEPR ID: DP17540
Authors: Marienolle Lefebvre; Etienne Lehmann; Michal Sicsic
Abstract: We theoretically express the Laffer tax rate on capital income as a function of the elasticities of capital income (the "direct" elasticity) and of labor income (the "cross" elasticity) with respect to the net-of-tax rate on capital income. We estimate these elasticities using salient capital tax reforms that took place in France between 2008 and 2017. Graphical evidence and Instrumental variables (IV) estimates confirm the existence of significant responses of both capital and labor income to capital tax reforms. Both approaches lead to positive cross responses, in contrast to the prediction of income-shifting models but in line with the two-period "working and saving" model. Cross responses are, however, about ten times lower than direct ones. We obtain a direct elasticity around 0.5 which is robust across specifications. Ignoring the cross elasticity leads to a Laffer rate around 68%. However, since labor incomes are much larger than capital incomes, the Laffer tax rate is especially sensitive to the cross elasticity. Using our estimated positive cross elasticity dramatically reduces the Laffer tax rate on capital income to around 57%, taking only income tax on labor income into account, and down to 35% when we also take payroll taxes into account.
Keywords: Optimal Tax; Laffer Tax Rate
JEL Codes: C23; C26; H21; H24; H31
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| capital tax reforms (H29) | capital income (E25) |
| capital tax reforms (H29) | labor income (J39) |
| marginal net-of-tax rate on capital income (H24) | capital income (E25) |
| marginal net-of-tax rate on capital income (H24) | labor income (J39) |
| cross elasticity of labor income with respect to marginal net-of-tax rate on capital income (H31) | Laffer rate (H21) |
| capital tax reforms (H29) | cross elasticity of labor income with respect to marginal net-of-tax rate on capital income (H31) |