A GENERAL MODEL OF THE BEHAVIORAL RESPONSE TO TAXATION: Other Applications and Conclusions 2

Thus, to understand the real incentives facing the multinational enterprise, one must calculate what Grubert and Slemrod (forthcoming) call an “income-shifting-adjusted cost of capital.” They estimate a particular functional form of the general model of investment and income shifting applied to U.S. corporations in Puerto Rico, a notorious tax haven for certain U.S. corporations.

In all these settings the standard model of the behavioral response to taxation is a special case of a more general model in which individuals or firms can, at some cost, reduce the amount of income that is taxed by means other than altering variables that enter the utility, or production, function. In the model of labor supply, as long as the cost of avoidance depends on true labor income the real behavioral response to wage rates or tax rates depends on a mixture of the elasticity of substitution and the avoidance technology. The response of the tax base also depends on both factors. website

This model provides a conceptual structure for evaluating to what extent, and in what situations, the opportunities for avoidance mitigate the real response to large tax reforms such as the kind implemented in the United States in 1981 and 1986. It may help explain why the observed real response was not as large as many economists might have predicted in 1980. Whether it can do that will depend on the empirical success of this model in explaining the behavioral response to taxation.