Elasticity of Taxable Income and Optimal Taxation in Brazil

Using longitudinal data for a panel of Brazilian personal income tax returns between 2011 and 2017 we estimate the elasticity of taxable income (ETI) before and after deductions of personal income tax and calculate optimal taxation levels. The behavioral response is examined using a natural experiment, the phenomenon of ‘bracket creep’, an implicit increase in marginal tax rates of some taxpayers due to inflation. The estimated ETI unweighted by income is 0.76 for taxable income and 0.71 for gross income. When weighting by income, the respective ETIs are 0.64 and 0.61. We found much higher elasticities for the self-employed than for wage earners and deductions play a minor role. Considering base-shift, the revenue-maximizing rates are 47.6%, for the higher bracket and 38.2%, for the top 1% income, with associated marginal costs of efficiency of -0.61 and -1.34 Brazilian Reais (R$), respectively