Identifying behavioral responses to tax reforms:new insights and a new approach

We revisit the identification of behavioral responses to tax reforms and develop anew approach that allows for graphical validation of identifying assumptions and rep-resentation of treatment effects. Considering typical tax reforms, such as a reductionin the top income tax, we show that the state-of-the-art estimation strategy relies onan assumption that trend differences in income across the income distribution remainconstant in the absence of reforms. Similar to the pre-trend validation of differences-in-differences studies, this identifying assumption of constant trend differentials canbe validated by comparing the evolution of income in untreated parts of the incomedistribution over time. We illustrate the importance of our new validation approachby studying a number of tax reforms in Denmark, and we show how violations ofthe identifying assumption may drive the estimates obtained from the state-of-the-artstrategy.