Elasticity of Taxable Income: Evidence from Changes in Municipal Income Tax Rates in Finland

Abstract

The elasticity of taxable income (ETI) is a key parameter in income tax analysis both in terms of efficiency and tax revenue. This paper uses Finnish data to analyze the ETI. I use changes in flat municipal income tax rates as an instrument for overall changes in marginal tax rates. This instrument is not a function of individual income, and thus the ETI estimates are less susceptible to bias caused by differential trends across the income distribution. In general, instruments used in previous studies do not have this feature. My preferred estimate for the average ETI is 0.21.