How Do the Rich and Poor Respond Differently to Tax Changes?

Why do differences in elasticities  matter?

Understanding how taxpayers respond to taxes is crucial for setting effective and equitable tax policy. When the taxable base is highly responsive to changes in tax rates – that is, when the elasticity is high – optimal policy typically implies lower rates to minimise welfare loss.

Existing evidence, largely from income and wealth taxation, has found that high-income earners and wealthy individuals are more responsive to tax rate changes than other taxpayers (Meghir and Phillips, 2010).

However, these findings come from contexts in which richer taxpayers are better able to evade or avoid taxes, such as by converting income across bases. These opportunities are much less prevalent in the case of the property tax – where the base is easily observable and fixed, and the only margin of response is non-payment.

This project is directly relevant to property tax policy, especially in developing countries. Property taxes are one of the most under-utilised tax types in developing countries (Brockmeyer et al., 2023), though many countries are planning to introduce or revamp their property taxes. In addition, by examining a setting in which richer and poorer taxpayers are on a relatively ‘level playing field’, this project also aims to advance understanding of how and why elasticities vary across taxpayers.

Mexico City: an ideal context for studying the property tax

This project studies property tax compliance in Mexico City, using detailed administrative tax data provided by the Ministry of Finance of Mexico City. This context has been studied by complementary papers studying the relative role of tax policy and tax enforcement (Brockmeyer et al., 2023) and the role of public good provision for tax compliance (Brockmeyer et al., 2024).

Several features of the city’s property tax system allows for the identification of the elasticity. First, Mexico City's property tax schedule has notches that lead to jumps in the tax rate across tax brackets. Second, the property value formula used by the tax authorities is a function of the age of the property. As properties age, their value as determined by the formula declines and some fall down a tax bracket, leading to a sharp change in their tax liability. Third, a revaluation in 2011 increased tax liabilities for some properties. Fourth, tax rates were changed for certain brackets but not others. Multiple sources of variation allow for elasticities to be robustly estimated.

This project will also investigates why elasticities may differ across taxpayers. It will test potential mechanisms such as variation in enforcement intensity, tax salience, and liquidity constraints across the property value distribution. 

Brockmeyer, A., Estefan, A., Arras, K. R., & Suárez Serrato, J. C. (2023). Taxing Property in Developing Countries: Theory and Evidence from Mexico (NBER Working Paper No. 28637; p. w28637). National Bureau of Economic Research. https://doi.org/10.3386/w28637

Brockmeyer, A., Garfias, F., & Suárez Serrato, J. C. (2024). The Fiscal Contract up Close: Experimental Evidence from Mexico City (Working Paper No. 32776). National Bureau of Economic Research. https://doi.org/10.3386/w32776

Meghir, C., & Phillips, D. (2010). Labour supply and taxes. In J. A. Mirrlees & Institute for Fiscal Studies (Great Britain) (Eds.), Dimensions of tax design: The Mirrlees review. Oxford University Press.