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«VATT Publications 68 Essays on behavioral responses to income taxes Tuomas Matikka GOVERNMENT INSTITUTE FOR ECONOMIC RESEARCH VATT PUBLICATIONS ...»

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VATT Publications 68

Essays on behavioral responses

to income taxes

Tuomas Matikka

GOVERNMENT INSTITUTE FOR ECONOMIC RESEARCH

VATT PUBLICATIONS

Essays on behavioral

responses to income taxes

Tuomas Matikka

Valtion taloudellinen tutkimuskeskus

Government Institute for Economic Research

Helsinki 2014

Tuomas Matikka, Government Institute for Economic Research

ISBN 978-952-274-126-4 (nid.)

ISBN 978-952-274-127-1 (PDF) ISSN 0788-4990 (nid.) ISSN 1795-3332 (PDF) Valtion taloudellinen tutkimuskeskus Government Institute for Economic Research Arkadiankatu 7, 00100 Helsinki Edita Prima Oy Helsinki, December 2014 Essays on behavioral responses to income taxes Tuomas Matikka Academic dissertation to be presented, by permission of the Board of the University of Tampere School of Management, for public examination at the Paavo Koli sali (Pinni A), Kanslerinrinne 1, on December 5, 2014, at 12 a.m.

i Abstract This dissertation consists of an introductory chapter and four empirical essays on behavioral responses to income tax incentives. The introductory chapter presents the conceptual background of the welfare analysis of income taxation, highlighting the crucial roles of behavioral elasticities and the structure of the behavioral response. In addition, I present an overview of recent empirical literature on behavioral responses to income taxes.

The first essay studies the extent and significance of income-shifting behavior among the owners of privately held corporations in Finland. The dual income tax system in Finland offers considerable incentives and opportunities for income-shifting between wages and dividends for business owners. Extensive panel data at both the owner and firm level together with Finland’s dividend tax reform of 2005 enable us to credibly analyze the empirical significance of income-shifting. The results show that incomeshifting is evident. The income-shifting response is homogenous across different owners and firms. However, the size of the income-shifting incentive affects the extent of income-shifting activity, indicating that the costs of income-shifting are non-negligible.

The second essay focuses on distinguishing between real responses and incomeshifting. Previous literature shows that income taxes affect the behavior of high-income earners and business owners. However, it is still unclear how much of the response is caused by real economic activity (labor supply, effort etc.), and how much is due to income-shifting and other tax-planning activities. This distinction is important because it can greatly affect the welfare implications. We build a model that formalizes the analysis of the elasticity of taxable income under income-shifting possibilities. We show that income-shifting accounts for over two thirds of the overall behavioral response among the owners of privately held corporations in Finland. This considerable incomeshifting response halves the marginal excess burden of income taxes among Finnish ii business owners, compared to the traditional framework where the overall behavioral response determines the welfare loss.

The third essay studies the elasticity of taxable income (ETI) in Finland. To identify the average ETI, I use changes in flat municipal income tax rates as an instrument for changes in the overall marginal tax rates. This instrument is not a function of individual income, which is the basis for an exogenous tax rate instrument. In general, instruments based on predicted tax rate changes as used in many previous studies do not have this feature. In addition, I estimate behavioral responses for the subcomponents of taxable income, such as working hours, fringe benefits and tax deductions. This structure of the overall ETI has rarely been studied in previous literature. My preferred estimate of ETI in Finland is 0.27, which indicates moderate but non-negligible welfare effects.

The subcomponent analysis suggests that working hours and wage rates respond less than tax deductions and irregular forms of compensation such as fringe benefits. This implies that the overall behavioral response is not driven by changes in deep individual utility arguments, such as the opportunity cost of working.

The fourth essay analyzes the role of different frictions in explaining different behavioral responses to similar tax incentives. Recent literature shows that optimization frictions attenuate behavioral responses to tax incentives, compared to the underlying long-run structural elasticity. However, the literature has not addressed the role of different frictions in explaining heterogeneous responses to tax incentives. To study this issue, we analyze to what extent and in what manner taxpayers respond to different tax incentives. We compare the behavioral effects induced by different tax and transfer incentives and institutions within similar or even the same individuals in Finland. We use a local estimation approach and the bunching method in order to produce clear and comparable evidence. We find that taxpayers do not respond at all to small changes in tax incentives, but do respond to large and salient incentives. Moreover, the patterns iii of response indicate that some taxpayers are unable to respond even to large incentives, and some are unaware of the tax incentives.





Keywords: income taxation, behavioral responses, individuals iv

–  –  –

Tämä väitöskirja sisältää johdantoluvun ja neljä itsenäistä empiiristä artikkelia verotuksen vaikutuksesta yksilöiden käyttäytymiseen. Johdantoluku esittelee verotuksen taloudellista tehokkuutta käsittelevää teoreettista kirjallisuutta. Lisäksi johdantoluvussa esitellään keskeisimmät empiiriset tulokset tuloverotuksen käyttäytymisvaikutuksista.

Väitöskirjan kaksi ensimmäistä artikkelia käsittelevät yrittäjien käyttäytymisvaikutuksia. Ensimmäisessä artikkelissa tarkastellaan yrittäjien tulonmuuntoa. Verokannustimista johtuva tulonmuunto vähentää verotuloja sekä heikentää verotuksen taloudellista tehokkuutta. Tutkimuksessa tarkastellaan vuoden 2005 yritys- ja osinkoverouudistuksen vaikutuksia. Uudistus kannusti listaamattomien osakeyhtiöiden omistajia maksamaan itselleen mieluummin palkkaa kuin nostamaan osinkoja. Tulosten perusteella verokannustimien muutos vaikutti selvästi omistajien käyttäytymiseen, ja tulonmuuntoaktiivisuus oli hyvin samanlaista eri omistajaryhmissä ja erilaisissa yhtiöissä. Lisäksi havaitaan, että verokannustimen koko vaikutti tulonmuuntoon palkka- ja osinkotulojen välillä.

Toisessa artikkelissa erotellaan tuloverotuksen aiheuttamat reaaliset käyttäytymisvaikutukset tulonmuunnon aiheuttamista vaikutuksista. Aikaisempien tutkimusten perusteella verotus vaikuttaa selvästi yrittäjien käyttäytymiseen. On kuitenkin epäselvää, kuinka suuri osuus kokonaisvaikutuksesta aiheutuu reaalitaloudellisista päätöksistä ja kuinka suuri osa verosuunnittelusta. Erilaisten käyttäytymisvaikutusten erottelu on tärkeää, sillä erilaiset tavat reagoida verokannustimiin vaikuttavat arvioihin verotuksen taloudellisesta tehokkuudesta. Artikkelissa tutkitaan listaamattomien osakeyhtiöiden omistajien käyttäytymistä Suomessa. Tulosten perusteella yli kaksi kolmasosaa verotuksen aiheuttamasta käyttäytymisvaikutuksesta on selitettävissä tulonmuunnolla.

v Huomattava tulonmuuntovaikutus pienentää merkittävästi arviota verotuksen aiheuttamasta taloudellisesta tehokkuustappiosta.

Kolmannessa artikkelissa tutkitaan verotettavan tulon joustoa Suomessa. Verotettavan tulon jousto mittaa sitä, kuinka monta prosenttia veropohja muuttuu, kun yhdestä lisäeurosta käteen jäävä osuus muuttuu yhden prosentin. Verotettavan tulon jouston avulla voidaan kokonaisvaltaisesti arvioida tuloverotuksen aiheuttamaa tehokkuustappiota. Korkeampi tuloveroaste voi esimerkiksi vähentää tehtyjä työtunteja sekä lisätä verosuunnittelua. Verotettavan tulon jousto huomioi eri kanavat, joilla tuloveroihin voidaan reagoida. Tutkimuksessa hyödynnetään kunnallisverotuksessa tapahtuneita muutoksia. Kunnallisverotus tarjoaa hyvän vertailuasetelman erilaisten henkilöiden välille, sillä kunnallisveroprosentti ei riipu henkilön tuloista. Lisäksi kunnallisveroprosentin muutokset muuttavat veroasteita kaikissa tuloluokissa. Tulosten perusteella verotettavan tulon jousto on Suomessa keskimäärin 0,27. Tuloveroprosentin vaikutus veropohjan kokoon on tilastollisesti merkitsevä, mutta tuloverotuksen aiheuttama taloudellinen tehokkuustappio on kuitenkin maltillinen. Tulokset antavat myös viitteitä siitä, että työtunnit ja tuntipalkka reagoivat heikommin veroasteen muutoksiin kuin epäsäännölliset tulot, kuten luontoisedut ja verovähennysten määrä.

Neljännessä artikkelissa tarkastellaan käyttäytymisvaikutuksiin tai niiden puuttumiseen vaikuttavia tekijöitä. Viimeaikaisen tutkimuskirjallisuuden perusteella käyttäytymisvaikutuksiin liittyvät kitkatekijät, kuten jäykät työmarkkinat sekä epätietoisuus verosäännöistä ja -kannustimista, heikentävät veronmaksajien reagointia verokannustimiin. On kuitenkin edelleen epäselvää, miten erityyppiset kitkatekijät selittävät havaittua käyttäytymistä, ja miten erilaiset tekijät vaikuttavat havaitun käyttäytymisvaikutuksen kokoon ja muotoon. Tutkimuksessa vertaillaan erilaisten verokannustimien vaikutusta samankaltaisten tai samojen henkilöiden käyttäytymiseen. Tutkimuksessa hyödynnetään paikallista ja tulojakauman muotoon perustuvaa estimointimenetelmää vi (nk. bunching -menetelmä). Menetelmällä saadaan luotettavaa ja vertailukelpoista evidenssiä verokannustimien käyttäytymisvaikutuksista. Tulosten perusteella kitkatekijät vaikuttavat merkittävästi veronmaksajien käyttäytymiseen. Veronmaksajat eivät reagoi pieniin kannustimiin, mutta jos verokannustimet ovat merkittäviä sekä selkeitä ja helppo ymmärtää, niin käyttäytymisvaikutuksia havaitaan. Lisäksi havaitaan, että työmarkkinoihin liittyvät kitkatekijät heikentävät keskimääräisiä käyttäytymisvaikutuksia vaikka verokannustimet olisivat merkittäviäkin.

–  –  –

The long process of writing this PhD thesis is finally coming to an end, and it is time to express my gratitude to everyone who helped and supported me along the way. First, I would like to thank my supervisor Professor Jukka Pirttilä. His insightful guidance and prudent advice has greatly improved this thesis and considerably increased my understanding of economics in general. I am grateful to Jarkko Harju and Tuomas Kosonen for being co-authors of articles in this thesis and for many fruitful discussions on economics, not to forget the various activities unrelated to research. It has been a privilege to work with both of you, and I am already looking forward to all future research projects.

I thank the two pre-examiners of this thesis, Professor Hannu Tervo and Associate Professor Håkan Selin, for their insightful and perceptive comments which greatly improved the manuscript.

I have been privileged enough to work in many different institutes and interact with many intelligent and insightful people during my graduate studies. First, I would like to thank Professor Matti Tuomala for his encouragement and advice in the beginning of my graduate studies. In addition, I thank other professors and all my colleagues and friends at the University of Tampere for many great conversations both on and off the topic of economics.

I thank Director Seija Ilmakunnas and the former Director, Dr. Jaakko Kiander for the opportunity to visit the Labour Institute for Economic Research for one year. Also, I would like to thank the personnel at the Institute for a creative research environment.

I would especially like to thank Olli Kärkkäinen with whom I shared a room with for all the discussions on various aspects of life.

I am grateful to Professor Joel Slemrod for the opportunity to visit the University of Michigan for one year, and for his insightful guidance, advice and comments on my viii work. In addition, I thank everyone at the Office of Tax Policy Research in Michigan for a warm welcome and great conversations on economics and academic life.

For the last two and a half years I have been privileged to work at the Government Institute for Economic Research, VATT. I am grateful to Research Director Seppo Kari and Dr. Essi Eerola for the opportunity to work at VATT, and for numerous discussions and very insightful comments. I would also like to thank the many colleagues at VATT for all their support, advice and encouragement.

I am especially grateful for the financial support I have received from the Finnish Doctoral Programme in Economics, Yrjö Jahnsson Foundation, Finnish Cultural Foundation, OP-Pohjola Group Research Foundation, Nordic Tax Research Council and Emil Aaltonen Foundation.

I am enormously grateful to my mom Anne and to my dad Jukka for their encouragement and support during this project. I would also like to thank my grandfather Lasse and my grandmother Mari for their endless encouragement. In addition, I would like to express my gratitude to my sister Elina and her husband Sami for all their support, and especially for their endless patience with accommodating me in their apartment for numerous occasions during the first and second year of my PhD studies. In addition, I thank all my friends outside the economics profession for all the support.

Finally, the greatest thanks go to my wonderful wife Marja who unconditionally and tirelessly supported me during the process. You mean the world to me, and I would have not been able to do this without you being there.

I dedicate this book to my son Otto, who has brought a great deal of joy and laughter into our lives.

–  –  –



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