Tax Deduction Matters : Elasticities of the Laffer Curve, Taxable Income, and the Tax Revenue

In this study, we use a simple dynamic general equilibrium model to demonstrate that the tax deductions affect the three elasticities: that of the Laffer curve (the Laffer elasticity, hereafter), taxable income, and the tax revenue. We first decompose the Laffer elasticity, which consists of the elasticity of taxable income (ETI) and the tax revenue elasticity. To quantitatively evaluate the importance of tax deductions, we calculate the analytical solutions of these elasticities with respect to labor and capital income under the steady state in the general equilibrium model with exogenous deduction and a social security tax. Using Japanese data, we conduct a numerical simulation with plausible parameter values. The simulation yields results that are consistent with empirical literature on public finance: an unstable peak of the Laffer curve, wide range of estimates for ETI, and the tax revenue elasticity greater than 1