The Elasticity of Taxable Income: The case of South Africa

23 August 2017
Publication Type: Working Paper
JEL Code: H21, H31, J22

A central tax policy parameter that has received much attention internationally, but about which there is substantial uncertainty, is the overall elasticity of taxable income. The size of this elasticity is of critical importance in the formulation of tax and transfer policy, as well as for the study of the welfare implications of tax decisions. This paper uses a panel of individual tax returns for the period 2009 – 2013 and the phenomenon of ’bracket creep’ as source of tax rate variation to construct instrumental variable estimates of the sensitivity of income to changes in tax rates. We find that the overall elasticity of taxable income is approximately 0.3, while that of broad income is significantly lower. This overall elasticity is primarily due to the elastic response of taxable income for taxpayers who have incomes above R380 000, who have an elasticity of closer to 0.4. The estimates suggest an optimal marginal tax rate for the top 10% of income earners that is generally in line with the current income tax schedule. However, results also suggest that there is little scope for raising marginal rates on high-income earners without inducing a negative revenue response.

Series title: Working paper 702
1 August 2017