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The optimal tax literature has modelled income shifting as a decision along the intensive margin. However, income shifting involves significant fixed costs, which give rise to an important extensive margin. In this article, we show that the distinction between the intensive and extensive margins has crucial policy implications. We consider a population of agents differing in terms of productivities, labor supply elasticities and abilities to shift income. In the extensive margin model the distinction between income creation and income shifting breaks down and the social planner should not in general combat shifting. In particular, numerical simulations of a linear tax model suggest that the social planner should allow for income shifting if elasticities are heterogeneous in the population. We demonstrate that the qualitative conclusions drawn from the simple linear tax model carries over to a model with two fully non-linear tax schedules.
