Tax bunching, income shifting and self-employment

• We propose a dynamic extension to Saez (2010) bunching formula.
• We distinguish bunching based on real responses and income shifting.
• We provide direct evidence of income shifting and bunching for Danish self-employed.
• We find that more than half of the observed bunching is driven by income shifting.
• We estimate a structural elasticity in the range of 0.14–0.42.

This paper proposes a dynamic extension to Saez (2010) bunching formula that allows us to distinguish bunching based on real responses and income shifting. We provide direct evidence of income shifting and pronounced bunching in taxable income for the Danish self-employed. If income shifting was neglected in this case, we would estimate a taxable income elasticity in the range of 0.43–0.53 and conclude that taxable incomes were highly sensitive to changes in marginal tax rates. We show, however, that more than half of the bunching in taxable income is driven by intertemporal income shifting, implying a structural elasticity of 0.14–0.20.