Emmanuel Saez on Elasticity (Economics) - Dictionary of Arguments
Saez I 12
Elasticity/capital/labour/Saez/Zucman: Tax incidence: The question of who pays the taxes collected by governments today is (...) what economists call, quite confusingly, “tax incidence.” For example, what would happen if the corporate tax rate were cut?
Saez I 100
Elasticity: the most inelastic factor of production bears the burden of taxes, while the most elastic factor dodges them. Concretely, if capital is very elastic - saving and investment collapse whenever capital is taxed—then labor bears the burden of capital taxation. But just as capital taxes can be shifted to labor, so too can labor taxes be shifted to capital. This happens if labor is very elastic - that is, if people work substantially less when the taxation of their earnings rises. In one of the oldest and most famous analyses of tax incidence, Adam Smith in The Wealth of Nations explained how taxes on wages could be shifted to capital. If farmers are at the subsistence level (they earn no more than what they need to barely survive), taxing their wage would make them starve.
Question: How elastic are capital and labor? Does the capital stock, in particular, vanish when capital taxes
Saez I 101
rise? If it does, then taxing capital is indeed harmful and slashing corporate taxation can be in the long-run interest of workers. >Tax incidence/Saez.
Tradition: According to most commentators, capital’s extreme elasticity is a law of nature, as certain as gravity. But this belief—like other stark predictions from basic economic theory (for instance, that the minimum wage must destroy employment)—needs a reality check.
Saez I 105
Capital/SaezVsTradition/ZucmanVsTradition: Capital is not very elastic, but it can be obscured. Rich people can hide wealth offshore. Multinational companies can shift profits to Bermuda.
Corporation profits: The same conclusion holds true for the taxation of corporate profits, the form of capital income that’s widely seen as most elastic. The way that corporations respond to international differences in tax rates is not primarily by moving their factories to low-tax places, but by shifting paper profits to tax havens.
Saez I 131
Elasticity/Ramsey/Saez/Zucman: In the 1920s, the prodigy mathematician and economist Frank Ramsey formally proved that if all taxpayers faced the same tax rate, the rate that maximizes government revenue is inversely proportional to the elasticity of taxable income.(1) What does this mean? >Taxation/Ramsey.
If taxable income is inelastic, it means that when tax rates rise, reported income does not change much.
Example: In that case, the US Treasury mechanically collects more revenue by hiking tax rates. By contrast if taxable income is very elastic, then high tax rates reduce the tax base so significantly that they don’t raise much revenue and are undesirable.
Ramsey rule: That’s the cardinal rule of optimal taxation, called the Ramsey rule: governments should not tax too much what’s elastic. >Ramsey rule/Saez.
1. Ramsey, Frank P. “A Contribution to the Theory of Taxation.” Economic Journal 37, no. 145 (1927): 47–61._____________Explanation of symbols: Roman numerals indicate the source, arabic numerals indicate the page number. The corresponding books are indicated on the right hand side. ((s)…): Comment by the sender of the contribution. Translations: Dictionary of Arguments The note [Author1]Vs[Author2] or [Author]Vs[term] is an addition from the Dictionary of Arguments. If a German edition is specified, the page numbers refer to this edition.