Public Finance Review

1-31
ª The Author(s) 2015
Measuring Revenue- Reprints and permission:
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maximizing DOI: 10.1177/1091142115589970
pfr.sagepub.com

Elasticities of
Taxable Income:
Evidence for the US
Income Tax

John Creedy1,2 and Norman Gemmell3

Abstract
This article considers the question of whether marginal tax rates (MTRs) in
the US income tax system are on the ‘‘right’’ side of their respective Laffer
curves. Previous attention has tended to focus specifically on the top MTR.
Conceptual expressions for these ‘‘revenue-maximizing elasticities of tax-
able income’’ (ETIL), based on readily observable tax parameters, are pre-
sented for each tax rate in a multi-rate income tax system. Applying these to
the US income tax, with its complex effective marginal rate structure,
demonstrates that a wide range of revenue-maximizing ETI values can be
expected within, and across, tax brackets and for all taxpayers in aggregate.

1
Public Economics and Taxation, Victoria University of Wellington, Wellington, New Zealand
2
New Zealand Treasury, Wellington, New Zealand
3
Public Finance, Victoria Business School, Victoria University of Wellington, Wellington, New
Zealand

Corresponding Author:
Norman Gemmell, Victoria Business School, Victoria University of Wellington, P.O. Box 600,
Wellington 6140, New Zealand.
Email: norman.gemmell@vuw.ac.nz

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2 Public Finance Review

For some significant groups of taxpayers, these revenue-maximizing ETIs

appear to be within the range of empirically estimated elasticities.

Keywords
income tax revenue, taxable income elasticity, Laffer curve

Since Feldstein (1995), the ‘‘elasticity of taxable income’’ (ETI) has become
a standard concept for measuring behavioral responses to tax rate changes,
mainly for personal income taxes. The ETI measures the response of taxable
income (TI) with respect to variations in the net-of-tax rate, 1  t, rather than
the tax rate, t, and hence is expected to be positive. It captures the combined
impacts of various economic responses to changes in marginal income tax
rates. These include labor supply variations, shifts to tax-favored income
sources, tax avoidance, and evasion.
A useful property of the ETI is that the various economic responses to a
tax rate change are captured in a single parameter. Under certain conditions,
it also provides a convenient method of approximating the welfare effects of
tax changes.1 Partly as a result, the ETI has become an established approach
in numerous empirical studies, reviewed recently by Saez, Slemrod, and
Giertz (2012).2
Within the ETI framework, the revenue-maximizing tax rate (sometimes
labeled ‘‘revenue-neutral tax rate’’) has become of particular interest in recent
studies for reasons outlined subsequently. However, a limitation of this focus
on revenue-maximizing tax rates is that their estimation relies on estimated,
or assumed, ETIs. These ETIs can be context- and taxpayer-specific, and
empirically difficult to identify robustly, as is recognized by Slemrod and
Kopczuk (2002), Saez, Slemrod, and Giertz (2012), and others.3
This article therefore focuses on a different, but related, way of examin-
ing revenue-maximization aspects. It instead asks the question: for a given
actual tax rate, what ETI value is consistent with a revenue-maximizing out-
come? Given considerable uncertainty regarding ETI estimates, but knowl-
edge of precise marginal tax rates (MTRs) in an actual or proposed tax
structure, the revenue-maximizing ETI provides a benchmark against which
estimated or hypothesized ETIs may be compared. Modeling a multi-rate
income tax structure in this context thus provides an answer to the following
question: how large does a hypothesized or estimated ETI have to be before
a change to a particular MTR (or rates) is expected to generate a revenue-
neutral response? This elasticity, consistent with the maximum point on the

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Creedy and Gemmell 3

Laffer curve, is referred to subsequently as the revenue-maximizing elasti-

city of TI, labeled ETIL.
The next section discusses the recent literature on revenue-
maximization within the ETI framework. The third section derives expres-
sions for the multi-rate equivalent of the revenue-maximizing ETI for the
top rate, which is obtained as an aggregation across revenue-maximizing
ETIs for individual taxpayers. It is shown that the key components can be
calculated using only the details of the effective marginal rates and
income thresholds describing the complete tax structure, together with
information on the distribution of TI. The fourth section illustrates ETIL
values for the US federal and state income taxes, based on effective mar-
ginal tax rates (EMTRs) calculated by Congressional Budget Office (CBO
2005). The fifth section returns briefly to the question explored by Giertz
(2009b) to consider the revenue-maximizing MTR for each tax bracket,
for given assumed values of the ETI. Brief conclusions are in the final
section.

Revenue-maximization and the ETI

In the context of the elasticity of TI literature, the revenue-maximizing tax
rate has become of particular recent interest for at least two reasons. Firstly,
following Saez (2001), Slemrod and Kopczuk (2002), Kopczuk (2005), and
Saez, Slemrod, and Giertz (2012), it can be shown that, at least for the top
MTR, the revenue-maximizing rate is closely related to an optimal top rate,
with both being functions of the ETI and the shape of the top tail of the
income distribution. The optimal and revenue-maximizing rates deviate,
depending on the assumed contribution to social welfare of top rate tax-
payers.4 Using this approach applied to the 2005 US income tax and
Internal Revenue Service (IRS) TI data, Giertz (2009b) estimated the
revenue-maximizing top rate between 41 percent and 78 percent based on
assumed ETIs of 1.0 and 0.2, respectively.5
Secondly, Werning (2007), Saez, Slemrod, and Giertz (2012), and others
have argued that, for a given income tax structure, the set of welfare-
improving tax reforms is closely related to whether an increase in a partic-
ular MTR is expected to produce an increase in revenue of some minimum
amount. Werning (2007), for example, demonstrates that for a tax reform to
generate a Pareto-superior income tax structure, it is required to reduce all
tax rates but yield the same or more revenue overall, even though it can be
expected that some taxpayers will respond in ways that reduce revenue
while other taxpayers’ responses enhance revenues. Pareto efficiency

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4 Public Finance Review

therefore requires the income tax as a whole to be on the revenue-increasing

side of the Laffer curve.6
However, establishing reliable values for the revenue-maximizing tax
rate is not straightforward because it depends on the estimated or assumed
value of the ETI. As Slemrod and Kopczuk (2002) have pointed out,
whereas labor supply elasticities might reasonably be treated as an ‘‘immu-
table parameter,’’ based solely on preferences, this is not the case for the
ETI. Rather, the ETI is also a function of various policy decisions such
as the nature of attitudes to tax compliance, types of noncompliance avail-
able, and the degree of enforcement. In addition, empirically it has proved
difficult to obtain reliable estimates of the elasticity of TI, even where the
focus of attention has been on a particular tax reform and specific subsets of
taxpayers such as those at the top of the income distribution.
As suggested previously, given these uncertainties regarding taxpayers’
actual ETI values, an alternative way of addressing the revenue maximiza-
tion issue is to rearrange the question to ask: for a given actual tax rate, what
ETI value yields a revenue-neutral outcome when one or more tax rates
change? For the case of a single proportional tax rate or the top tax rate
in a multi-rate system (the focus of most of the literature), this turns out
to be a fairly simple transformation because all revenue raised at this rate
is paid by taxpayers for whom it is also their marginal rate.
Consider, for example, the revenue-maximizing or ‘‘Laffer-maximum’’
top MTR, tLK (where there are k ¼ 1, . . . , K marginal rates). Saez, Slemrod,
and Giertz (2012) and Giertz (2009b) show that this is given by:
1
tLK ¼ ; ð1Þ
1 þ Za

where Z is the (assumed or estimated) ETI for top-rate taxpayers, and a is

the ratio of average TI above the top threshold, yK , to the difference
between yK and the top threshold income level, aK.7 A simple rearrange-
ment of this expression yields the equivalent revenue-maximizing elasticity
of TI in the top tax bracket as:
ZLK ¼ ð1  tK Þ=ðatK Þ; ð2Þ

where ZLK is the revenue-neutral ETI for Kth bracket taxpayers. This can be
shown to be equivalent to the ETIL for a proportional tax system, but with
the addition of a in the denominator of equation (2).
As shown in later sections, for rates below the top rate, deriving the ETIL
is less straightforward and is sensitive to the composition of taxpayers

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Creedy and Gemmell 5

across tax brackets, especially in income tax structures such as in the United
States with various income ranges reflecting rate progression (increasing
marginal rates) and ranges with reductions in effective tax rates where
means-tested benefit payments, deductions, or tax credits are subject to
taper rates. Further, with multiple marginal rates, tax revenue is raised both
from the application of a marginal rate to each taxpayer (with associated
behavioral responses), and revenue raised at lower, intramarginal rates from
each taxpayer, except for taxpayers in the lowest tax bracket.
The next section addresses this issue by first deriving the ETILs for indi-
vidual taxpayers and then aggregating those to derive equivalent expres-
sions for various taxpayer aggregates.

The ETI in Multi-rate Tax Structures

This section demonstrates how the elasticity of tax revenue with respect to a
bracket’s marginal rate depends on characteristics of the tax structure, the
relevant elasticity of TI, and (for aggregate values) the income distribution.
This then allows the revenue-maximizing ETI to be derived for multiple
MTRs. The analysis first focuses on the individual, from which aggregate
revenue-maximizing ETI expressions can be obtained as weighted averages
of individual values.
For convenience, the distinction between gross income and TI is ignored,
though this distinction is likely to be important where there are extensive
income tax deductions.8 As stressed by Kopczuk (2005), such deductions
are also a particularly relevant source of tax avoidance and income-
shifting responses, as distinct from real resource responses. Where there are
endogenous, income-related deductions, the following analysis must be in
terms of income after deductions have been made, as in the case of the illus-
trations in later sections. In modeling revenue responses, the analysis con-
centrates only on income tax, making no allowance for possible shifting to
other lower taxed income sources such as through incorporation or other
tax-favored entities.

Effective Income Thresholds

The multistep tax function depends on a set of income thresholds, ak , . . . , aK,
and a corresponding set of MTRs tk , . . . , tK applying above the corre-
sponding thresholds. These rates and thresholds can represent the statu-
tory income tax schedule, or the schedule of effective marginal rates
and thresholds associated with the overall system of income taxes and

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6 Public Finance Review

transfers.9 The tax paid by individual i with income of yi, denoted by T(yi),
can be written as:
T ð yi Þ ¼ t1 ð yi  a1 Þ a1 < y i  a2
; ð3Þ
¼ t1 ða2  a1 Þ þ t2 ð yi  a2 Þ a2 < y i  a3
and so on. If yi falls into the kth tax bracket, so that ak < yi  ak þ 1, T(yi) can
be expressed for k  2 as:
X
k 1    
T ð y i Þ ¼ t k ð y i  ak Þ þ tj ajþ1  aj ¼ tk yi  ak ; ð4Þ
j¼1
P  
where ak ¼ t1k kj¼1 aj tj  tj1 and t0 ¼ 0. Thus, the tax function facing any
individual taxpayer in the kth bracket is equivalent to a tax function with a
MTR, tk, applied to income measured in excess of an effective threshold, ak .

Changes in Individual Tax Payments

Consider a change in tax liability of an individual facing the rate, tk, result-
ing from an exogenous increase in tk with other rates and all thresholds
unchanged. Writing T(yi) ¼ Ti, rearranging the total derivative, dTi ¼
qTi qTi a db
qyi dyi þ qtk dtk , in elasticity form using the general notation, Zb;a ¼ b da,
gives:
ZTi ;tk ¼ Z0Ti ;tk þ ZTi ;yi Zyi ;tk : ð5Þ
Here Z0b;a ¼ ab qb qa denotes a partial elasticity. In the case where an income
change does not lead to a movement across an income threshold,
ZTi ;yi ¼ Z0Ti ;yi .10 Equation (5)  canbe rewritten in terms of the elasticity of
TI, ETI, using Zyi ;1tk ¼  1t tk
k
Zyi ;tk , such that:
 
0 tk
ZTi ;tk ¼ ZTi ;tk  Z Z : ð6Þ
1  tk Ti ;yi yi ;1tk
The first term in equation (5) may be said to reflect a pure ‘‘tax rate,’’ or
‘‘mechanical,’’ effect of a rate change, with unchanged incomes, while the
term after the minus sign captures the ‘‘tax base’’ effect, resulting from the
incentive effects on TI and the revenue consequences of that income
change.11
The individual revenue elasticity is given by:
yi
ZTi ;yi ¼ > 1; ð7Þ
yi  ak

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Creedy and Gemmell 7

such that the elasticity of revenue with respect to the marginal rate faced by
an individual in the kth tax bracket is12:
  
0 yi tk
ZTi ;tk ¼ ZTi ;tk  Z : ð8Þ
yi  ak 1  tk yi ;1tk
The first term, Z0Ti ;tk , the positive mechanical effect, is obtained by dif-
ferentiating equation (4):13
tk ð yi  ak Þ ð yi  ak Þ Tk ðyi Þ
Z0Ti ;tk ¼ ¼ ¼ : ð9Þ
T ðyi Þ yi  ak T ðyi Þ
Individuals’ mechanical effects therefore differ with their incomes and
the tax structure, represented in equation (9) by differences between the kth
threshold, ak, and the kth effective threshold, ak . Furthermore, since ak is a
tax rate weighted average of all tax thresholds up to and including the indi-
vidual’s MTR, this effective threshold enables the full mechanical revenue
effect to be captured when a rate or threshold below the taxpayer’s marginal
rate bracket is changed. As can be seen in equation (8), it also features in the
behavioral response component.
The second term in equation (8) combines the three elements that form
the ‘‘behavioral effect.’’ In addition to the ETI, two terms are associated
with the tax structure and the individual’s income level. The larger the
behavioral effect is, the larger is the individual’s ETI, the higher is tk, and
the closer is the taxpayer’s income to the effective threshold. Each element
after the minus sign in equation (8) is positive, and so the overall behavioral
response unambiguously reduces revenue.
In view of the importance of the closeness of yi to the effective income
threshold, ak , the following discussion refers to this as an ‘‘income-thresh-
old’’ effect though this is often referred to in the fiscal drag literature as a
revenue elasticity.14
An analytical expression for the revenue-neutral elasticity of TI for an
individual is readily obtained by setting the left-hand side of equation (8)
to zero to yield15
  
yi  ak 1  tk
ZLyi ;1tk ¼ Z0Ti ;tk ; ð10Þ
yi tk

  
yi  ak 1  tk
¼ ; ð11Þ
yi tk

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8 Public Finance Review

where ZLyi ;1tk denotes the revenue-maximizing ETIL, and the expression in
equation (11) is obtained using equation (9). An observed or estimated ETI
value greater than ZLyi ;1tk implies that any increase in the taxpayer’s MTR
reduces income tax revenue from that taxpayer. Assessing likely magni-
tudes of the revenue-maximizing elasticity using equation (11) is straight-
forward, requiring information only on the individual’s income, yi, and
the highest tax threshold below yi, ak.16
Expressions such as equation (11) provide revenue authorities with infor-
mation about which taxpayers can be expected to have revenue-reducing
responses to an MTR increase, for a given actual ETI: those for whom
Zyi ;1tk > ZLyi ;1tk . For example, the revenue-neutral ETI, ZLyi ;1tk , is higher
for taxpayers further above a threshold (yi  ak) and for those on lower mar-
ginal rates (higher 1  tk values). However, these revenue-reducing responses
do not imply that such taxpayers are necessarily more responsive to the tax
change. Even if all taxpayers were to have the same actual ETI values, equation
(11) identifies those for whom this implies a revenue-neutral outcome.

Aggregate Values of ETIL

For many tax policy purposes, aggregate revenue responses are of most
interest. This section turns to the variation in aggregate revenue, where two
distinctions need to be made. The first concerns the aggregate revenue
obtained from those individuals whose TI falls into the kth tax bracket and
thus face the MTR, tk. The second distinction concerns the total revenue
raised at the rate, tk. This includes the tax covered by the first category and
tax paid at that rate by individuals who fall into higher-rate brackets.
Revenue-maximizing responses by those taxpayers for whom tk is their
marginal rate is often of policy interest (even though it is not a maximum
across all taxpayers) because it represents the total behavioral response,
assuming no income effects. Since politicians often raise or lower a partic-
ular tax rate as a way of targeting a specific group of taxpayers for distribu-
tional reasons, the aggregate ETIL for this group of taxpayers indicates the
threshold responsiveness for those taxpayers—whether they pay more or
less revenue than before the reform.
Consider changes in the tax revenue obtained from the Nk individuals for
whom ak þ 1 < yi < ak and who therefore face the MTR of tk. First convert
equation (8) into changes, rather than elasticities:
   
dTi qTi yi dyi Ti
¼  : ð12Þ
dtk qtk yi  ak dð1  tk Þ yi

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Creedy and Gemmell 9

Importantly, this does not consider the extra revenue obtained from all
those with yi > ak þ 1 and who do not change their TI in response to the
change in tk (since, by assumption, there are no income effects on the ETI):
this is considered subsequently. Assuming that no individuals move into a
lower tax bracket as a result of the tax rate increase, aggregating over indi-
viduals in the kth bracket gives:
X Nk    
Nk
dTi X Nk
qTi X yi dyi Ti
¼   : ð13Þ
i¼1
dtk i¼1 qtk i¼1 yi  ak dð1  tk Þ yi

Suppose it is required that the total change in revenue, obtained from

those in the bracket, from an increase in the rate tk is 0. Then, setting the
left-hand side of equation (13) equal to zero gives:
X Nk     X Nk
yi dyi Ti qTi
 ¼ ; ð14Þ
i¼1
yi  ak dð1  tk Þ yi i¼1
qtk

and substituting for Ti using Ti ¼ tk ( yi  ak ), this becomes:

X
Nk
dyi X
Nk
qTi
tk ¼ : ð15Þ
i¼1
dð1  tk Þ i¼1 qtk

Hence,
P k
d Ni¼1 yi 1X Nk
qTi
¼ : ð16Þ
dð1  tk Þ tk i¼1 qtk
P k 

Write Ni¼1 yi ¼ Yk and define ZLY ;1t  as the aggregate ETI for
k k T fromYk

which aggregate revenue, paid by those for whom akþ 1 < yi < ak, is
unchanged. That is, the tax raised from Yk is at its maximum, given the tax
structure.
 Multiplying
 both sides of equation (16) by ð1t Yk
kÞ
and writing
qTi tk qTi Ti
qtk ¼ Ti qtk tk ¼ tTki Z0Ti ;tk ; gives:
   Nk
L  1 1  tk X Ti 0
ZY ;1t ¼ Z : ð17Þ
k k T from Yk Yk tk i¼1 k
t Ti ;tk
  
yi tk
From equation (10), Z0Ti ;tk ¼ yi a 
L
1tk Zyi ;1tk so that substitution
k
finally gives:
 X Nk  
 yi
ZLY ;1t  ¼ ZLyi ;1tk : ð18Þ
k k T from Yk
i¼1
Y k

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10 Public Finance Review

Hence, the aggregate ETI in the kth tax bracket, such that the revenue
from those whose income falls in the bracket at the given tax rate is a max-
imum, is an income-share weighted average of individual elasticities.17
The expression in equation (18) shows the aggregate ETIL as an income-
share weighted average of individual elasticities of those in the tax bracket.
It demonstrates the relationship between individual and aggregate elastici-
ties. However, an alternative expression can be obtained more directly
qTi
from the tax structure. For those in the kth tax bracket, qt k
¼ yi  ak and
PNk
qTi
qtk ¼ Yk  Nk ak . Substituting these terms into equation (16), and letting
i¼1
yk ¼ Yk =Nk , gives:
   
 1  tk yk  ak
ZLY ;1t  ¼ : ð19Þ
k k T from Yk tk yk
Comparing equation (19) with the equivalent individual revenue-
maximizing elasticity in equation (11) shows that the aggregate elasticity sim-
ply replaces individual income, yi, with mean income in the kth bracket, yk .
As noted previously, the result in equation (18) or equation (19) refers only
to the revenue from those who pay tax at the marginal rate, tk. The increase in tk
generates additional revenue from those with yi > akþ1 and for whom there is
dTi
only a ‘‘mechanical effect,’’ dt k
, to take into account because their marginal rate
has not changed. The expression in equation (19) can refer to total revenue col-
lected at the rate tk only if it is applied to the top rate of tax, tk.18
Letting Nkþ denote the number of people with yi > akþ1, so that
P
Nkþ ¼ Kj¼kþ1 Nj , it is clear that for each individual with yi > akþ1,
dTi
dtk¼ akþ1  ak , so that to allow for this extra revenue gain, it is necessary
to add Nkþ ðakþ1   ak Þ to the right-hand side of equation (13).

Define ZLY ;1t  as the aggregate ETI in the kth tax bracket, such that
k k Total T
revenue from those whose income falls in the bracket plus revenue from
those in higher tax brackets, is at a maximum at the given tax rate. Then,
 X Nk    
 yi 1  tk Nkþ ðakþ1  ak Þ
ZLY ;1t  ¼ ZLyi ;1tk þ : ð20Þ
k k Total T
i¼1
Yk tk Yk

Similarly, for total revenue including that obtained by the Nkþ taxpayers
whose income falls into higher brackets:
  

L  1  tk ðyk  ak Þ þ ðNkþ =Nk Þðakþ1  ak Þ

ZY ;1t  ¼ : ð21Þ
k k Total T tk yk

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Creedy and Gemmell 11

Comparing the two elasticities in equations (19) and (21), it can be seen
that the total revenue-maximizing elasticity in equation (21) is higher by
ðNkþ =Nk Þðakþ1  ak Þ= yk . That is, as expected, behavioral responses by
those with incomes in the kth bracket would have to be larger before total
revenue falls in response to an MTR rise compared to when only revenue
from those in the kth bracket is considered. How much larger can be seen
to depend on the component terms in ðNkþ =Nk Þðakþ1  ak Þ= yk . The form
in equation (21) has the advantage that it is easily calculated given informa-
tion on the tax bracket, the average income in the bracket and the number of
people in, and above, the bracket.
Equation (21) can alternatively be rewritten in terms of the revenue
raised from taxpayers within and above the kth tax bracket, rather than the
number of taxpayers. This decomposition allows an aggregate revenue-
maximizing ETI to be calculated from data on revenue collected at marginal
and less-than-marginal rates, which are available from the IRS, for
example.
Let R represent aggregate revenue over all individuals, while Rk refers to
the aggregate revenue obtained from all individuals whose incomes fall in
the kth tax bracket.
 Hence,
 Rk is the aggregate over individuals in the kth
bracket of tk y  ak values. Let R(k) denote the aggregate amount raised
only at the rate tk from individuals who fall into the kth bracket. Thus,
R(k) is the sum over individuals in the kth bracket of tk ðy  ak Þ values.
Furthermore, Rþ ðk Þ refers to the aggregate revenue obtained at the kth rate
from individuals whose incomes fall into higher tax brackets. Hence, Rþ ðk Þ
is the number of all individuals in higher tax brackets multiplied by
tk ðakþ1  ak Þ. Formally,
 
Rk ¼ tk Nk yk  ak ; ð22Þ

Rðk Þ ¼ tk Nk ðyk  ak Þ; ð23Þ

Rþ þ
ðk Þ ¼ tk Nk ðakþ1  ak Þ: ð24Þ

For the top marginal rate, where k ¼ K, clearly NKþ ¼ 0. Using these def-
initions, it can be shown that equation (21) can be rewritten as:
   " #
L  1  tk ð
y k  ak Þ Rþ
ðk Þ
ZY ;1t  ¼ 1þ : ð25Þ
k k Total T tk yk Rðk Þ

Comparing the aggregate ETIL for revenue from those with incomes in
the kth tax bracket in equation (19), with the ETIL for total revenue in

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12 Public Finance Review

equation (25), it can be seen that the latter is greater to the extent of the
value of Rþ
ðk Þ =Rðk Þ . This ratio is expected to be positive for all k tax brackets
except the top, Kth, bracket, where Rþ ð K Þ ¼ 0. Possible values for these ratios
for the k US income tax brackets are considered subsequently.

US Revenue-maximizing ETIs
This section illustrates the revenue-maximizing ETIs and their components
for the US federal and state income tax systems. Though statutory MTRs
and thresholds associated with income tax schedules apply to most tax-
payers, identifying the EMTRs and thresholds applicable to specific tax-
payers is not straightforward. Taxpayers’ personal circumstances, such as
marital and tax filing status, number of children and dependents are impor-
tant. When combined with federal payroll taxes, state income taxes, and the
eligibility rules around federal social benefit programs, the outcome is typi-
cally a complex set of interactions that generate highly individual effective
marginal rate schedules.
A detailed examination of individuals’ EMTRs was undertaken by the
CBO (2005) for US income taxpayers by filing status across a wide range
of TI levels in 2005. These include federal, state, and payroll taxes (for
Social Security and Medicare).19
Though the main interest in revenue-maximizing aspects of TI elastici-
ties is typically for aggregate revenues raised from all, or subsets of, tax-
payers, because aggregate results are obtained here as weighted averages
of individual ETILs, this section first illustrates ETILs for single filers (with
no children) for TI levels up to US$0.5 million, based on EMTRs for the
federal income tax from CBO (2005). Equivalent ETILs for other taxpayer
types are readily calculated from the CBO data.20

Revenue-maximizing ETIs: Individuals

Table 1 shows the statutory MTRs and TI thresholds for a single filer in
2005. The final column of the table reports the effective income threshold,
ak , for each income bracket.
The data in table 1, applied to equation (11), could be used to calculate
values for ETIL at each income level. An actual or estimated ETI greater
than the equivalent ETIL for each TI level would imply that a cut in the
applicable MTR would yield an increase in revenue from this taxpayer and
vice versa. However, as CBO (2005) shows, the itemized deductions, tax
credits, and phaseout, or abatement, rates of the US federal income tax

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Creedy and Gemmell 13

Table 1. Statutory Federal Income Tax Structure: Single Filer 2005.

Income Tax Effective Income Tax Effective

threshold rate threshold threshold rate threshold
k ak tk ak k ak tk ak

1 0 0.10 0 4 71,950 0.28 19,620

2 7,300 0.15 2,434 5 150,150 0.33 39,397
3 29,700 0.25 13,340 6 326,450 0.35 55,800

system, together with differing statutory thresholds and rates by tax filing
status, lead to widely differing EMTRs across income levels and taxpayers.
For example, CBO (2005, 15) shows how these vary for various filer types
under a number of simplifying assumptions.21
In addition to substantial differences between the EMTRs and statutory
marginal rates at various income levels, in some cases EMTRs fall as
income increases. The addition of state and payroll taxes further compli-
cates schedules of EMTRs, raising them in general but also creating addi-
tional income ranges over which EMTRs fall (see CBO 2005, 16–19).22
In addition, the overlapping nature of the federal, state, and payroll tax
bases often serves to increase behavioral effects from MTR changes but
with no mechanical revenue gains. For example, an increase in the overall
EMTR due to a federal income tax rate increase that induces an income-
reducing behavioral response will also lower the state income tax base, but
with no compensating state tax rate increase to generate additional revenues
mechanically.
Using CBO (2005) data, together with equation (10) or equation (11),
allows illustrative revenue-maximizing ETIs to be constructed. The
resulting profiles of ETILs across income levels for a single filer are shown
in figure 1, where the income ranges US$0–US$100,000 and $100,000–
US$500,000 are shown separately.23 Different scales are used on the verti-
cal axes of the upper and lower panels of the figure, which also shows single
filer ETILs based on the statutory schedule in table 1. According to IRS data
for 2005, single filers made up 23 percent of total taxable returns.24
It can be seen that ETILs at income levels under about US$20,000 can
take large negative or positive values.25 These low-income ETILs are
included here for completeness but are of limited relevance in view of the
potential importance of adjustments at the extensive margin at such income
levels, for which this analysis is unsuited. Nevertheless, they emphasize the
potential for perverse responses to tax rate changes at these lower-income
levels. Large positive or negative behavioral responses to tax rate changes

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14 Public Finance Review

Figure 1. Revenue-maximizing elasticities of taxable income (ETIs)—Single filer.

could have surprising effects on revenues, given the variability of ETILs in

this region where EMTRs fluctuate around zero.
These illustrations suggest that the precise location of taxpayers along
the income scale is important for individual revenue responses to tax rate
changes. At the aggregate level, as discussed subsequently, it becomes
important to know where most taxpayers are located with respect to EMTR,
rather than statutory rate, thresholds. For example, IRS data on the distribu-
tion of TIs for single filers discussed in the next section (see figure 2) sug-
gest that a high percentage of those taxpayers have incomes in the
US$40,000–US$50,000 range. Figure 1 shows that the appropriate ETIL for
such taxpayers can be quite different depending on whether statutory or
effective tax rates are used in the calculation. In addition, US$40,000 turns
out to be a critical EMTR threshold, such that changes in the distribution of
single filers’ TIs from that observed in 2005 could have nontrivial impacts
on their estimated ETILs.
The individual revenue-maximizing ETIs considered in this section,
though purely illustrative for particular household types, suggest ranges
of incomes—sometimes several short income ranges and sometimes fewer

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Creedy and Gemmell 15

Figure 2. Revenue-maximizing elasticities and taxable income (TI) shares.

but wider ranges—over which ETILs are relatively low. Whether this is
likely to generate revenue reductions in aggregate in response to EMTR
increases depends on the weight of those and other taxpayers in the overall
distribution of TIs. This is examined in the following section.

Revenue-maximizing ETIs: Aggregates

Calculation of an aggregate ETIL across the US taxpaying population, or
subsets of taxpayers such as those within individual statutory rate tax brack-
ets, requires detailed data on the number and personal characteristics of the

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16 Public Finance Review

Table 2. Percentage Income Shares by Taxable Income Band.

Married-Joint (M-J) Head of Household (HoH) Single (S) Total

AGI ($000s) M-J All HoH All S All All

20–25 0.1 0.1 1.0 0 4.9 1.2 1.3

25–30 0.3 0.2 3.4 0.2 6.0 1.5 1.8
30–40 1.3 0.9 14.4 0.7 12.5 3.0 4.6
40–50 2.5 1.8 15.6 0.7 11.3 2.7 5.3
50–75 11.9 8.4 26.3 1.2 18.8 4.6 14.2
75–100 13.8 9.8 10.7 0.5 8.9 2.2 12.4
100–200 25.4 18.1 11.4 0.5 10.9 2.6 21.2
200–500 15.9 11.3 6.1 0.3 6.8 1.6 13.2
500–1,000 7.5 5.4 3.0 0.1 3.2 0.8 6.3
>1,000 21.3 15.1 7.7 0.4 10.3 2.5 18.0
100 71 100 5 100 24 100

relevant taxpayers, which is beyond the scope of the present analysis. Nev-
ertheless, this section illustrates likely orders of magnitude by combining
ETIL information on the individual taxpayer types examined above with
IRS data on the distribution of US personal incomes.
There are two aggregate ETILs of interest: those associated with changes
in revenue from  taxpayers in the tax bracket(s) where marginal rates
L 
change, ZY ;1t  , and those associated with total revenue changes,
k k T from Yk


ZLY ;1t  . To simplify the exposition, these aggregate ETILs are labeled
k k Total T
ETILYk and ETILT , respectively, subsequently.
Using 2005 data on US adjusted gross incomes (AGIs) and TIs from
returns filed with the IRS, table 2 shows the share in total TI (both within
taxpayer types, and across all three types: married filing jointly, head of
household, and single).26 The table shows, for example, in column two, that
among married joint-filers (M-J), less than 5 percent of TI is earned by M-J
taxpayers with AGI below US$50,000; around 70 percent of M-J TI is earned
by taxpayers with AGI over US$100,000 and almost 30 percent from those
with AGI over US$500,000 (which also accounts for around 20 percent of all
TI; see column 3).27 Equivalent percentages for single filers are lower, at 59
percent, 31 percent, and 14 percent.
To explore the impact of these distributions on aggregate ETILYk values
requires taxable income-weighted averages of individual ETILs as shown
earlier, which in turn requires taxpayer unit record data to identify values

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Creedy and Gemmell 17

Table 3. ETILs by Taxable Income Band.

Married-Joint (M-J) Head of Household (HoH) Single (S)

AGI ETIL ETIL ETIL ETIL ETIL ETIL

($000s) Fed. FPS Fed. FPS Fed. FPS

20–25 2.9 0.5 0.6 0.3 1.8 0.6
25–30 0.3 0.1 0.3 0.1 2.5 0.5
30–40 0.5 0.2 0.7 0.2 3.1 0.4
40–50 0.9 0.3 1.7 0.2 0.3 0.2
50–75 2.2 0.4 0.9 0.3 1.0 0.5
75–100 1.7 0.4 0.2 0.1 1.1 0.5
100–200 0.2 0.2 0.4 0.3 0.4 0.3
200–500 0.4 0.3 0.3 0.2 0.2 0.2
500–1,000 0.1 0.0 0.3 0.2 0.4 0.3
>1,000 1.5 1.1 1.5 1.2 1.6 1.2
Note: Fed. ¼ federal income tax only; FPS ¼ federal, payroll, and state income taxes.

of yi, tk, ak , and ak for each taxpayer. In the absence of this level of detail,
values of ETILYk within each AGI band are obtained as unweighted averages
of ETILYks for each taxpayer type, based on the data underlying figure 1 for
single filers and similar data from CBO (2005) for M-J and head of house-
hold (HoH) filers. These are shown in table 3. Equivalent ETILYks which
include CBO (2005) approximations for payroll and state income taxes are
also shown in table 3.
With only three taxpayer types involving specific assumptions regarding
the number of children and so on, these ETILYks do not capture the full het-
erogeneity in individual ETILYks. However, the differences within broad fil-
ing types lead to different thresholds at which the various EMTRs apply
rather than substantially altering EMTR values. The ETILYk values in table
3 capture the major source of differences across income bands and filing
types, namely, the impact of different effective thresholds.
For example, for AGI over US$20,000—where values are more readily
interpreted—table 3 shows that unweighted average values within each
income band, and across filer types, are often quite low (less than one or less
than 0.5). This is especially true when payroll and state taxes are included.
For top earners with AGI in excess of US$1 million, the aggregate values
shown in table 3 use the ETIL applicable to the individual with average
income in this highest income band, yK ; see equation (21).28 As mentioned
earlier, as incomes rise above US$1 million, the ETILYk approaches
ð1  tK Þ=tK , where tK is the highest EMTR faced by this taxpayer; that

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18 Public Finance Review

Table 4. Revenue Ratios by Taxable Bracket.

Averagea
Tax Tax Number of Tax returns taxable Income
bracket rate tax returns where yi > akþ1 income range Ratio:
k tk Nk (millions) Nþ
k (millions) yk ($) ðakþ1  ak Þ Rþ
ðkÞ =RðkÞ

1 10 26.70 77.48 5,220 7,300 4.06

2 15 49.32 28.16 25,186 22,400 0.72
3 25 22.00 6.16 67,249 42,250 0.33
4 28 3.73 2.43 136,051 78,200 0.80
5 33 1.48 0.95 261,910 176,300 1.02
6 35 0.95 0.00 1,148,189 — 0.00
a
The taxable income definition used here is the Internal Revenue Service (IRS) category of
‘‘modified taxable income.’’ Estimates here exclude ‘‘capital gains’’ returns.

is, for tK ¼ 0.35, ETILYk approaches 1.86, though for many high-income tax-
payers EMTRs exceed 35 percent. For example, for married joint filers,
CBO (2005) estimates a top EMTR (including payroll and state taxes) of
0.43, implying an asymptotic ETILYk ¼ 1:33.
Figure 2 combines the information in tables 2 and 3 to show, for single
and married joint filers, how the values of the ETILs, estimated for groups of
taxpayers by income band, relate to the TI shares of those same taxpayers.29
Consider married joint filers, illustrated in the top half of figure 2. ETILs are
generally low for taxpayers with annual TIs around US$25,000 to
US$40,000, but their income shares are also very low, such that there would
be a limited impact on an overall ETIL estimate across all taxpayers. How-
ever, taxpayers with incomes in the range US$100,000 to US$1 million also
have relatively low ETILs (on average) but have a much larger share of TI.30
Taxpayers facing the top MTR—approximately those with TIs above
US$500,000—reveal a wide range of ETIL values, from around 0 to 0.5
on average for incomes up to US$1 million to around 1.5 on average for
incomes above US$1 million.
As equations (19) and (25) show, the weighted average ETILYk estimates
for taxpayers in different income brackets in table 3 refer to revenue raised
only from the kth bracket taxpayers, Nk. To estimate total revenue
responses to a change in tax rate, tk, including by taxpayers facing mar-
ginal rates above tk requires estimates of the ratio, Rþ ðk Þ =Rðk Þ , in equation
(25). This contributes to a form of ‘‘multiplier,’’ ½1 þ ðRþ ðk Þ =Rðk Þ Þ, that
transforms estimates of ETILYk in table 3 into estimates of ETILT for total
revenue in equation (25).

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Creedy and Gemmell 19

Estimates of Rþ ðk Þ and R(k) can be obtained from equations (22) to (24)

using IRS data on Nk, Nkþ , and yk , together with tax schedule information
on the tax bracket thresholds, ak. The resulting ratios of interest,
RþðkÞ =Rðk Þ , k ¼ 1, . . . , 6, are given in table 4. For the top marginal rate
bracket, Rþ þ
ð6Þ ¼ 0 so that Rð6Þ =Rð6Þ ¼ 0.
As expected, the table reveals that tax paid at the lowest, 10 percent, tax
rate is dominated by revenue from higher rate taxpayers rather than those
for whom 10 percent is their marginal rate. For this tax rate, the ratio
Rþð1Þ =Rð1Þ ¼ 4:06.
31
For successively higher tax brackets equivalent values
are 0.72 (15 percent), 0.33 (25 percent), 0.80 (28 percent), and 1.02 (33 per-
cent) and of course for the highest tax rate, accounting for the largest rev-
enue share (one-third), the ratio is zero.32
These estimates of Rþ ðkÞ =RðkÞ suggest that, excluding taxpayers with
incomes in the top or bottom statutory tax brackets (above US$326,450
or below US$7,300), the illustrative weighted average estimates of ETILYK
in table 3 would need to be multiplied by values between about 1.3 (i.e.,
1 þ 0.33) and 2 (i.e., 1 þ 1.02) to obtain ETILT s associated with maximum
total revenue;
 see
 equation (25). For top tax rate changes, however, the
ETILT ¼ ETILYk can be relatively low, depending on how far above the
threshold the bulk of taxpayers are located, the ETILT in table 3 could con-
ceivably exceed actual values.
While the values of ETILYk in table 3 together with the values of Rþ ðkÞ =RðkÞ
in table 4 provide illustrative orders of magnitude only, they are suggestive of
an overall federal income tax that involves tax rates that are likely to be on the
revenue-increasing side of the Laffer curve. Though some people might argue
for actual ETIs greater than around 1.0 for some high-income taxpayers, few
would claim that these values apply across the taxpaying population.33
Values of ETILYk around 0.2–0.5, as shown in table 3, are within the range
of plausible values for actual ETIs estimated from US taxpayer data. But,
excluding taxpayers above  the top tax threshold, actual ETIs would need
to be higher, due to the Rþ ðkÞ =R L
ðkÞ multiplier effect on ETIYk , to yield
L
ETIT , before total revenue would be expected to fall when an individual
tk is raised. The same argument probably applies, but with less force, for
ETILT values that include payroll and state taxes, where lower ETILYk values
make it somewhat easier for actual values to exceed revenue-maximizing
equivalents. Nevertheless, with ETILYk estimates for some taxpayer groups in
h i
table 3 around 0.2 to 0.5, and multiplier effects of 1 þ Rþ ðk Þ =R ð k Þ ranging
from 1 to 2, some weighted ETILT values could be sufficiently low as to suggest

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20 Public Finance Review

some caution is warranted before concluding that these parts of the US income
tax are well below a revenue-maximizing structure (even if this is likely correct
for taxpayers with incomes over US$1 million). More detailed analysis of
ETILT s based on large samples of individual taxpayers at different income lev-
els would provide more confidence around such estimates and conclusions.

The Revenue-maximizing Tax Rate

As mentioned in the introduction, recent analyses of revenue-maximization
aspects of tax reforms have focused on the revenue-maximizing tax rate,
especially the top rate. Revenue-maximizing values for each tax rate, tk
(k ¼ 1, . . . , K), in a multi-rate system are obtained by setting the change
in revenue in equation (8) to zero and rearranging to give the revenue-
maximizing rate, tLk , in terms of a given ETI. This gives:
"  ! #1
L yi Zyi ;1tk
tk ¼ þ1 : ð26Þ
ðyi  ak Þ Z0Ti ;tk

Substituting for the mechanical effect in equation (26) and using

¼ ðyyi a
Z0Ti ;tk kÞ
from equation (9), further rearrangement shows that:
ð i ak Þ
ðyi  ak Þ
tLk ¼ : ð27Þ
yi ð1 þ Zyi ;1tk Þ  ak

For a proportional income tax, where ak ¼ ak ¼ 0, equation (27) reduces

to the Fullerton special case of tLk ¼ 1=ð1 þ Zyi ;1tk Þ.34 This tax rate, tLk , is
the rate that maximizes revenue from a particular taxpayer with a specified
ETI value, or the rate that maximizes revenue from all taxpayers if they
share this uniform ETI response.
Giertz (2009b, 128–31) calculates values of revenue-maximizing tax
rates for the 2005 US federal statutory income tax brackets, based on a
range of ETI values from 0.2 to 1.0. For the lowest bracket (10 percent tax
rate in 2005), he finds tL1 ranges from 0.88 to 0.97. For the top bracket (35
percent tax rate), tL1 ranges from 0.71 to 0.78, as the ETI, assumed uniform
across all taxpayers, falls from 1.0 to 0.2.
As with the ETIL profiles across TI levels, profiles of tLk by individuals’
TI levels can also readily be illustrated. Figure 3 shows values of tLk using
equation (27) for the statutory federal income tax based on five ETI values
in the range 0.2 to 1.0.35 In addition to tLk rising as incomes increase above

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Creedy and Gemmell 21

Figure 3. Revenue-maximizing tax rates.

each tax threshold, these profiles tend to shift downward in successively

higher tax brackets.
One way to interpret these profiles is that, if all taxpayers within a given
bracket have the same ETI response, then any tax rate set for that bracket
involves taxpayers toward the lower threshold having tLk < tk while those
toward the upper threshold are more likely to have tLk > tk . Consider, for
example, the second highest tax bracket, between US$150,150 and
US$326,450, where tk ¼ 0.33. Based on the statutory federal tax schedule,
figure 3 suggests that for the lowest ETI ¼ 0.2, almost all taxpayers (those
above about US$167,000) would be in the revenue-increasing range, with
tLk > 0:33. However, if ETI ¼ 1.0, the reverse would be the case because
only a small range of incomes immediately below US$326,450 would have
tLk > 0:33 (approximately from US$290,000 to US$326,450).
Given these large variations in tLk across TI levels, table 5 shows
revenue-maximizing tax rates for single filing taxpayers associated with the
average reported TI within each of the AGI bands examined previously.
These are shown for assumed ETIs of 0.2 and 1.0, with the relevant 2005
statutory federal MTRs, and combined federal-payroll-state EMTRs for a
single filer (no children) in the two right-hand columns. Although the stat-
utory rate is well below the revenue-maximizing rate when ETI ¼ 0.2 is
assumed, this is not always the case when comparing with the EMTRs,
especially at higher income levels. Also, based on a much higher ETI of
1.0, there are some cases where the revenue-maximizing rate appears to
be below the observed statutory MTR and/or the EMTR.

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22 Public Finance Review

Table 5. Revenue Maximizing Tax Rates by AGI Bands: Single Filer.

Rev-maximizing tax rate

AGI Average TIa Statutory Single filer
($000s) ($) (ETI ¼ 0.2) (ETI ¼ 0.1) MTR EMTRb

<5 1,025 83 50 0 7
5–10 1,902 83 50 0 7
10–15 4,445 83 50 0 7
15–20 8,771 25 6 10 35
20–25 13,356 37 10 10 28
25–30 17,983 41 12 15 33
30–40 24,200 64 26 15 33
40–50 32,722 43 13 15 32
50–75 45,249 36 10 25 41
75–100 66,236 66 28 25 41
100–200 105,313 39 11 28 34
200–500 245,182 55 20 33 40
500–1,000 595,114 63 26 35 42
>1,000 3,122,202 81 47 35 42
a
TI ¼ taxable income. bEMTR at average TI within each adjusted gross income (AGI) band.

These numbers should be treated cautiously. Revenue-maximizing tax

rates are not a linear function of average TI, as figure 3 makes clear. In addi-
tion, it is unclear how far taxpayers respond to these estimated effective
marginal rates (including payroll and state taxes) or the statutory rates
shown. However, the results in table 5 highlight two important properties.
First, the question of how revenue-maximizing tax rates compare with
observed rates needs to be considered carefully across the complete tax
schedule, not merely at the top end, and for specific taxpayer types. Second,
for the highest incomes (in excess of US$1 million), revenue-maximizing
tax rates appear to be relatively high (at around 47 percent to 81 percent
using the ETI range shown), and possibly well above generally observed top
tax rates.36 However, it is less clear that the outcome for top rate taxpayers
earning below US$1 million puts them well below the Laffer maximum
rate.
The estimates in table 5 may be compared with similar values estimated
for tLk by Giertz (2009b), based on the 2005 income tax, including federal,
payroll, and state taxes. He estimated tLk for five assumed values of the ETI
between 0.2 and 1.0. For the top tax bracket, for which comparisons are
most readily made, these are shown in table 6 along with the equivalent val-
ues from the analysis in this article. The Giertz (2009b) estimates appear to

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Creedy and Gemmell 23

Table 6. Revenue Maximizing Tax Rates.

Top tax bracket revenue-maximizing tax rate, tLK (percentage)

Income above: Source: ETI: 0.2 0.4 0.6 0.8 1.0

$326,450 Giertz (2009b) 78 63 53 46 41

$500,000 The present article 79 65 56 48 43
Note: Comparisons with, adapted from, Giertz (2009b). ETI ¼ elasticities of taxable income.

include all single filers in the top tax bracket in 2005 (with incomes above
US$326,450). The most relevant comparison is based on the two highest
income brackets in the IRS data in table 5; that is, income in excess of
US$500,000.37
The revenue-maximizing top tax rate estimates obtained by Giertz are
close to those obtained here for each ETI assumed value. His values are
slightly smaller, as expected since ETIs for taxpayers between US$326,450
and US$500,000 have been shown earlier to be among the lowest within the
top tax bracket and would therefore serve to reduce the Giertz estimates rela-
tive to those calculated for taxpayer incomes over US$500,000. With an
actual top tax bracket EMTR of approximately 41 percent, ETIs around
1.0 or greater imply that it is above the revenue-maximizing rate.38

Conclusions
Recent empirical literature on the ETI has been concerned with whether an
estimated ETI is likely to exceed a threshold value consistent with the
revenue-maximizing point on the Laffer curve. This has generally been
explored in the context of a single marginal rate system or with respect
to the top marginal rate only. For multi-rate income tax systems commonly
used in practice, this article has developed expressions for the revenue-
maximizing elasticity, ETIL: the elasticity value above which (for individ-
uals or in aggregate) responses to an MTR increase yields no additional
revenue.
It has shown that values of ETIL for individuals can be obtained from
generally available information on tax rates and individual incomes and that
ETILs in aggregate (yielding maximum total revenue when a marginal rate
is changed) are income-weighted averages of individual ETILs. Expressions
for the ETIL in a multi-rate income tax are composed of three elements: a
mechanical effect, an income threshold effect, and a tax rate effect. Each

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24 Public Finance Review

element varies across taxpayers within a given tax structure and across tax
structures. They are highly sensitive to the number and frequency of tax
rates and thresholds. As a result, individual ETIL values can be expected
to vary widely within and across income tax brackets, and approximations
based on a proportional income tax, or top marginal rate, are likely to be
inaccurate. The approach was also used to derive the associated revenue-
maximizing tax rate, tLk , for individual taxpayers within each income
bracket and in aggregate for assumed values of each taxpayer’s ETI.
Illustrating values for the revenue-maximizing ETIs, for taxpayers in dif-
ferent income ranges or tax brackets, based on the US income tax system in
2005 suggests that revenue-maximizing ETIs can be expected to take very
different values depending on the composition of income taxpayers accord-
ing to their personal tax filing and family characteristics, the structure of
effective tax rates and thresholds, and the distribution of taxpayer income
levels. As a result, it can be expected that, for a given actual ETI, the pros-
pect that this exceeds the revenue-maximizing value is very different across
taxpayer types.
The ETILs for groups of taxpayers are likely to be highly dependent on
which taxpayers are included in a sample, their incomes, and other char-
acteristics. Whether revenue-maximization occurs in aggregate depends
on the balance of individual revenue-reducing and revenue-enhancing
responses by different taxpayers. Many of the aggregate ETIL estimates
obtained here are relatively high, which is consistent with an income tax
system having rates generally below revenue-maximizing levels. How-
ever, this may not be the case for significant subsets of taxpayers across
a range of income levels.
One inference from this is that, where changes to MTRs and/or
thresholds are being considered (perhaps for variety of policy objec-
tives, including revenue-raising), the mixture of positive and negative
revenue responses by taxpayers that are observed after reform could
be quite different depending on precisely where rate/threshold adjust-
ments are made. Since governments often choose to change specific
MTRs within the schedule with the intention of targeting tax cuts or
increases at particular groups of taxpayers, being aware of the likeli-
hood of those targeted groups responding in revenue-increasing or
revenue-reducing ways could be important for policy choices.

Acknowledgment
We are grateful to the editor and two referees of this Review for helpful comments
on an earlier version of this article. Comments from Raj Chetty and participants at

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Creedy and Gemmell 25

the 2014 Annual Workshop of the Tax Administration Research Centre, at the Uni-
versity of Exeter, UK, are also gratefully acknowledged.

Declaration of Conflicting Interests

The author(s) declared no potential conflicts of interest with respect to the research,
authorship, and/or publication of this article.

Funding
The author(s) received no financial support for the research, authorship, and/or
publication of this article.

Notes
1. The assumption typically made in the empirical literature is that there are no
income effects, so that welfare changes can be approximated from observable
uncompensated elasticities, whereas compensated elasticities are usually
required. In addition, as Chetty (2009) shows, where the costs of tax avoidance
represent transfers between taxpayers rather than real resource costs, the elasti-
city of taxable income (ETI) no longer approximates the excess burden.
2. See also Goolsbee (1999) for a detailed critique of the ETI concept and a range
of empirical estimates from various US tax reforms. Giertz (2007, 2009a,
2009b) also discuss empirical methods and estimates and related literature in
some detail. Fieldhouse (2013) provides a nontechnical introduction to ETI and
other approaches to estimating the economic responses of tax changes.
3. More general revenue effects of changes in marginal tax rates (MTRs) in a
multi-rate income tax are examined by Creedy and Gemmell (2013).
4. The specification and important role of value judgments in comparisons of
revenue-maximizing and optimal tax rates is discussed in Creedy (2014).
5. For lower tax brackets, Giertz (2009b) reports even higher revenue-maximizing
tax rates, generally in the range 0.58 to 0.97 for the two lowest federal income
tax brackets (10 percent and 15 percent) and 0.31 to 0.69 for the other three tax
brackets (25 percent, 28 percent, and 33 percent). All estimates are obtained
assuming ETIs between 0.2 and 1.0.
6. Trabandt and Uhlig (2010) attempt to assess empirically how far the existing
systems of labor and capital income, and consumption taxation in the United
States and a sample of European countries are on the ‘‘wrong’’ side of the Laffer
curve. Only the capital income taxes of Sweden and Denmark appear to fall into
this category. See Trabandt and Uhlig (2012) for an update.
7. Based on their survey of more reliable estimates of long-run ETIs, Saez, Slem-
rod, and Giertz (2012, 42) argue that ‘‘the US marginal top rate is far from the
top of the Laffer curve.’’ This uses an estimate of a of around 1.5 to 2. As

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26 Public Finance Review

mentioned previously, based on the 2005 US income tax system, Giertz (2009b)
estimates the revenue-maximizing top (federal plus state) rate between 41 per-
cent and 78 percent depending on the assumed ETI.
8. For discussion of the empirical importance of income-related deductions in per-
sonal income tax regimes in Organisation for Economic Co-operation and Devel-
opment countries, see Caminada and Goudswaard (1996) and Wagstaff and Van
Doorslaer (2001). For the United States, Feldstein (1999, 675) estimated that total
income tax deductions in 1993 amounted to about 60 percent of taxable income.
9. In this latter case, tax revenue, T(yi), refers to total tax revenue net of any tax
credits and transfer payments.
10. For a proportional tax structure, with constant average and marginal rate, t, and
where y is arithmetic mean income, dT  þ td
dt ¼ y
y
dt and in terms of elasticities,
ZT;t ¼ 1 þ Zy;t , giving the result that revenue is maximized where Zy;t ¼ 1.
11. When discussing the effect on total revenue of a change in the top income tax
rate, Saez, Slemrod, and Giertz (2012, 5) refer to the tax rate effect as ‘‘mechan-
ical’’ and the second term as the ‘‘behavioral’’ effect, respectively. They do not
discuss the separate role of the revenue elasticity in this context; see Creedy and
Gemmell (2013).
12. Equation (8) provides a generalization of the Saez, Slemrod, and Giertz (2012,
7) result to all MTRs, but applied to individuals. The expressions developed ear-
lier for aggregate responses avoid a specific income distribution assumption,
whereas Saez, Slemrod, and Giertz assume a Pareto form for the upper tail. The
latter is not suitable for the whole distribution of taxpayers; see Creedy and
Gemmell (2013).
13. The partial individual elasticity, Z0T;tj , for j < k (i.e., for changes in MTRs
below the tax bracket in which the individual falls) is given by Z0T;tj ¼
  
tj ajþ1  aj =T ð yÞ, which is simply the tax paid at the rate, tj, divided by
total tax paid by the individual.
14. See, for example, Creedy and Gemmell (2002). This terminology also reduces
the number of references to elasticity measures. As yi > ak and a1  0, equation
(8) is undefined for yi ¼ 0; hence, it cannot account for behavioral responses at
the extensive margin such as where taxpayers exit the taxpaying population in
response to a tax rate change.
15. Fullerton (2008) gives the familiar revenue maximizing tax rate for a proportional
tax system, in terms of the ETI, as 1/(1 þ ETI). Using equation (10), and setting
Z0Ti ;tk ¼ 1 and ak ¼ 0 for a proportional tax, rearrangement of equation (10)
 1
gives the equivalent revenue maximizing tax rate, tL, as tL ¼ 1 þ Zyi ;1t .
16. Equation (8) can be used more generally to calculate maximum ETIs consistent
with any particular value of ZTi ;tk , in addition to the specific revenue-
maximizing case of ZTi ;tk ¼ 0.

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Creedy and Gemmell 27

17. The case of an equiproportionate increase in all MTRs requires a modification

of equation (18), whereby the individual elasticities on the right-hand side of
equation (18), ZLyi ;1tk ; are weighted by (Yk/Y).
18. Saez , Slemrod, and Giertz (2012) show that the actual or estimated ETI for the top
tax bracket is an income-weighted average of ETIs for individuals in that bracket.
19. Congressional Budget Office (CBO 2012a, 2012b) reports on a similar exercise
using 2012 data but only for low-to-moderate income level individuals—up to
US$50,000 (US$100,000) for single (married) filers—which also covers a
range of income-contingent federal transfer payments.
20. A longer working paper version of this article provides more details on the
impact of federal payroll taxes and state-level income taxes in addition to the
federal income tax; see Creedy and Gemmell (2014).
21. For example, all income is from employment, taxpayers have itemized deduc-
tions equal to 18 percent of their earnings; 40 percent of the deductions are state
and local taxes (not deductible under the Alternative Minimum Tax) and the
other 60 percent are charitable contributions and mortgage interest (deductible
under the Alternative Minimum Tax). CBO includes only some of the most
common features of the tax code in the examples.
22. In the CBO (2005) analysis, and that which follows, payroll tax rates include both
employers’ and employees’ contributions. State income taxes are simplified, with
a uniform 5 percent rate added to the federal rate, which ‘‘approximates the mar-
ginal rate in an average state’’ (CBO 2005, 16). CBO (2005, 16) acknowledge that
‘‘in reality, of course, the state marginal income tax rate depends on the laws in
each state,’’ but the uniform assumed 5 percent state tax rate ‘‘although an over-
simplification, give[s] a rough indication of the effect of state income taxes on
marginal tax rates.’’ See CBO (2005) for more details on the specific taxpayer and
schedule characteristics assumed. Reed, Rogers, and Skidmore (2011) provide an
alternative method of estimating MTRs for individual states.
23. Similar profiles, not reported here, can be obtained for head of household filers.
24. See http://www.irs.gov/uac/SOI-Tax-Stats—Individual-Statistical-Tables-by-
Filing-Status.
25. The axes have been truncated for illustrative purposes, but there are singulari-
ties in the ETIL profiles when effective marginal tax rates (EMTRs) equal zero
and values can reach as low as 14 in figure 1, when EMTRs are negative, such
as where the earned income tax credit phases in.
26. To save space, this table, and the next one, focuss on taxpayers with adjusted
gross income (AGI) in excess of US$20,000. As noted earlier, the ETIL esti-
mates probably have limited relevance for taxpayers on lower incomes. In any
case, those with incomes below US$20,000 represent a small fraction of total
AGI or taxable income.

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28 Public Finance Review

27. Equivalent percentages for numbers of M-J taxpayers in 2005 are, of

course, much smaller, at 23 percent below taxable income of US$50,000;
30 percent with taxable income above US$100,000 and 1.7 percent above
US$500,000.
28. From IRS data for 2005, these are around US$2.9 million for a married joint
filer and US$3.1 million for a single filer. Note that ETILYk ¼ ETILT for this top
tax rate case.
29. The band widths in figure 2 cover very different income range sizes, from
US$5,000 (at low incomes) to US$500,000 or more (at high incomes) reflecting
the IRS published breakdown available. The ETILs shown relate to the Federal
income tax only; see table 3.
30. The income shares in figure 2 represent shares of all taxpayers’ taxable incomes
in the IRS data. They therefore sum to around 71 percent and 24 percent for
married joint, and single, filers, respectively; see table 2.
31. This lowest tax bracket (10 percent) includes small numbers of tax returns in the
IRS data that are shown as paying tax at 5 percent or 8 percent (which together
account for about 4 percent of tax returns in this lowest group).
32. According to IRS 2005 data, tax revenue raised from taxpayers with marginal
rates across the six statutory brackets yield revenue shares of (from 1 to 6):
1.3 percent, 20.2 percent, 25.6 percent, 10.8 percent, 9.5 percent, and 32.5
percent.
33. See, for example, Weber (2012, 2014). Saez, Slemrod, and Giertz (2012) argue
that a plausible range of ETI values is between 0.1 and 0.4. However, Weber
(2014) obtains ETI estimates around 0.9 from examining US tax reforms,
mainly TRA86, over 1979 to 1990 using a sample from the Michigan IRS Tax
Panel which, it is suggested, does not oversample high-income individuals; see
Weber (2014, 92).
34. The Saez et al. expression for the revenue-maximizing top tax rate is given by
tLK ¼ ð1 þ aZyi ;1tK Þ1 , where a is a measure of average income in the top
bracket relative to the top threshold income. It can be shown that this is equiv-
alent to equation (27), where, in the present case, a ¼ yi =ðyi  aK Þ, for yi > aK.
35. Similar profiles can readily be created using effective marginal rate structures,
for alternative taxpayer types, and inclusive of state and payroll taxes.
36. Recall also that the EMTRs shown relate to labor income. To the extent that
higher-income taxpayers earn greater amounts of capital income, which gen-
erally face lower tax rates, the EMTRs shown may exaggerate the relevant
EMTRs.
37. Since the next highest income group reported in the IRS data is US$200,000–
US$500,000, a reliable split of the class data into above/below the top tax
threshold is not possible here.

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Creedy and Gemmell 29

38. One reason why the Giertz (2009b) results and those produced here for the
revenue-maximizing top tax rate in table 5 are similar is that, unlike the earlier
ETIL calculations, no income distribution information is required if it is
assumed that all taxpayers have the same ETI values. Hence, if both approaches
in table 5 use the same tax schedule information, they should yield similar tLK
estimates; see equation (27).

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Author Biographies
John Creedy is a professor of Public Economics and Taxation at the Victoria Uni-
versity of Wellington, and a principal advisor at the New Zealand Treasury. His pri-
mary research interests are in public economics, income distribution, and labor
economics.

Norman Gemmell is a professor of Public Finance at the Victoria University of

Wellington, New Zealand. His research interests are mainly in behavioral responses
to tax changes and tax compliance.

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