How do Top Earners Respond to Taxation? Evidence from a Tax Reform in Uruguay

In this paper, we analyze how top income earners (TIEs) respond to changes in personalincome taxation. Our identification strategy exploits a unique reform to Uruguay’s progressivelabor income tax schedule that affected differently the tax rates of taxpayers within the top 1%of the labor income distribution. Using a difference-in-differences approach and administrativerecords from the Tax and Social Security Agencies, we estimate elasticities on three margins ofbehavioral responses - intensive, extensive, and income shifting - to changes in (one minus) thetop labor income tax rate. Our estimates show a moderate intensive margin response, with theelasticity being 0.53 in our preferred specification. We find suggestive evidence that responseson labor income are partially explained by a real labor supply adjustment through fewer hoursworked. Responses on the extensive margin are larger and the semi-elasticity is slightly greaterthan 3. This response is mostly driven by income-shifting movements from labor to the corporateincome tax base. To calculate the efficiency costs of the reform, we propose a simple model whereindividuals can move between different tax bases. We estimate that, at most, the efficiency costsare 30% of the projected tax revenue