Public Sector Economics Measuring Substitution Effects with Multiple Margins of Distortion

The Income Tax Distorts on Multiple Margins Labor supply, housing demand, charitable giving, occupational choice, fringe benefits Are there summary indicators of the effects of taxes? “The” marginal tax rate: summarizes the effect on rates of substitution (Barro and Sahasakul) The compensated taxable income elasticity: summarizes the welfare effect (Feldstein, Slemrod)

Tax Favored vs. “Ordinary” Consumption c = ordinary consumption f = tax-favored consumption l = leisure, w(1-l) = pre-tax labor income t = constant tax rate, applied to Taxable Income w(1-l)-f compensated demand functions satisfy:

Income Tax is Equivalent to an Excise Tax on Ordinary Consumption dwc of the income tax is equivalent to the dwc of an excise tax on ordinary consumption can treat TI like it were a composite good  no need to separately study each tax-favored activity

Tax Favored Behavior in the Budget Constraint c = ordinary consumption f = tax-favored behavior, with cost  (f) l = leisure, w(1-l) = pre-tax labor income t = constant tax rate, applied to Taxable Income w(1-l)-f with transformed utility function, this environment is a special case of f in the utility function  dwc is proportional to the taxable income elasticity

Statutory vs Empirical Tax Rates f = tax-favored behavior, with cost  (f) T = convex tax function, applied to Taxable Income nw-f T is the statutory marginal tax rate the empirical marginal tax rate is dT/d(nw)