Identifying the Elasticity of Taxable Income

earlier versions. All errors are our own. We use matched panels from the Current Population Survey for survey years 1980-2009 along with a grouping instrumental variables estimator to provide new estimates of the elasticity of taxable income. Our identification strategy is to exploit the fact that federal and state tax reforms over the past three decades have differentially affected date-of-birth and education cohorts across states and over time, controlling for demographics, heterogeneous income trends, and fixed state, cohort, and year effects. We find that the elasticity is in the range of 0.4-0.55, depending on income measure. Based on standard formula and reasonable assumptions about the shape of the income distribution, the implication of our new estimates for tax policy is that the revenue-maximizing tax rate is nearly 30 percentage points lower than that obtained when we use the typical identification strategy in the literature. 1 Understanding how taxable income responds to marginal tax rates, i.e. the elasticity of