The consequences of taxation matter for the optimal design of the tax
system. Those consequences depend on behavioral responses to taxation, as
summarized by the elasticity of taxable income. Although this elasticity
depends on characteristics of preferences, such as the elasticity of
substitution between goods and leisure, it also depends on the avoidance
technology, and on the response of government to avoidance behavior. It
depends on the size of states, and the amount of tax coordination and
harmonization. To some degree the elasticity of response can be affected
by government policies, and the government need not accept it passively,
but rather should put in place policies that optimally determine it.