Identifying the Elasticity of Taxable Income

We use matched panels from the Current Population Survey along with a grouping instrumental variables estimator to provide new estimates of the elasticity of taxable income. Our identification strategy exploits the fact that federal and state tax reforms over the past three decades have differentially affected cohorts across states and over time. We find that the elasticity is in the range of 0.4–0.55. The implication of our new estimates for tax policy is that the revenue-maximising tax rate is nearly 30 percentage points lower than that obtained when we use the typical identification strategy in the literature.