The Role of Elasticities in Forecasting Irish Income Tax Revenue

Abstract

This paper examines the role of tax elasticities in forecasting tax revenue. Tax elasticities give the expected change in revenue for a change in the tax base. We examine how important the choice of elasticity is for forecasting income tax up to four years ahead. We find that using elasticities which were estimated using data adjusted for tax policy changes produces improved forecasts, particularly at longer forecast horizons. This improvement is statistically significant. These results are found using Irish data. However, this paper demonstrates a methodology with potential for widespread application in many other countries. Better forecasts of government revenue could aid better fiscal planning and medium-term budgeting.