A GENERAL MODEL OF THE BEHAVIORAL RESPONSE TO TAXATION: Introduction

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Legal responses to taxation can usefully be divided into two categories: real substitution responses, in which the tax-induced change in relative prices causes individuals to seek a different consumption bundle; and avoidance responses, in which taxpayers undertake a variety of tax planning, renaming, and retiming activities whose goal is to directly reduce tax liability without consuming a different mix of consumption. There is much evidence that suggests that the class of avoidance behaviors is more responsive to tax changes than are real substitution responses. Certainly, the evidence about the behavioral response to the major U.S. tax changes of the 1980s and 1990s suggests such a hierarchy of response (Slemrod, 1992, Auerbach and Slemrod, 1997).
At the top of the hierarchy, the most responsive to tax changes, is the timing of transactions. The doubling of capital gains realizations in 1986 in advance of the tax rate increase scheduled for 1987 is the prime example of this. In the middle of the hierarchy are financial and accounting responses, exemplified by the increase in home equity loans following the restrictions placed on the deductibility of consumer interest payments in 1986. Real substitution decisions, such as labor supply and savings, appear to be the least responsive category of behavioral response. Although the evidence on this question is mixed, the weight of the evidence suggests that these variables did not change in a significant way in response to the tax changes of the 1980s. credit