Estimating the Laffer tax rate on capital income: cross-base responses matter!

Abstract

We express the Laffer tax rate on capital income using direct elasticity (capital income response) and cross-elasticity (labor income response) to the net-of-tax rate on capital income. We estimate these elasticities using salient capital tax reforms that took place in France between 2008 and 2017. We use graphical analysis and instrumental variable estimates to confirm significant responses of capital and labor incomes. Both methods lead to positive labor responses, contrary to income-shifting predictions. Omitting cross-elasticity suggests a Laffer rate around 57 percent. However, incorporating our positive cross-elasticity estimate lowers the rate to about 43 percent, taking labor income tax into account.