Revenue-Maximising Elasticities

Popular discussions of tax revenues are often framed in terms of the well-known Laffer curve, in which total revenue is related to the tax rate, within a system which is implicitly thought of as having a single marginal rate. In practice tax structures have a number of marginal rates, and there is no single elasticity of taxable income that applies to all individuals at all income levels. This raises the question of whether estimates of the elasticity of taxable income can be expected to exceed values which generate revenue-reducing responses to marginal tax rate changes. This chapter answers this question by first establishing, in the context of a multi-rate income tax, expressions for the elasticity of taxable income, at any income level, above which an increase in the relevant marginal tax rate produces a decrease in tax revenue. This elasticity is referred to as the revenue-maximising elasticity of taxable income. It is shown how, using information on the complete distribution of taxable income, revenue-maximising elasticity values at aggregate levels can be obtained.