The Incentive Effects of Marginal Tax Rates: Evidence from the Interwar Era

59 Pages Posted: 24 Feb 2012 Last revised: 21 Apr 2023

See all articles by Christina D. Romer

Christina D. Romer

University of California, Berkeley - Department of Economics; National Bureau of Economic Research (NBER)

David H. Romer

University of California, Berkeley - Department of Economics; National Bureau of Economic Research (NBER)

Date Written: February 2012

Abstract

This paper uses the interwar period in the United States as a laboratory for investigating the incentive effects of changes in marginal income tax rates. Marginal rates changed frequently and drastically in the 1920s and 1930s, and the changes varied greatly across income groups at the top of the income distribution. We examine the effect of these changes on taxable income using time-series/cross-section analysis of data on income and taxes by small slices of the income distribution. We find that the elasticity of taxable income to changes in the log after-tax share (one minus the marginal rate) is positive but small (approximately 0.2) and precisely estimated (a t-statistic over 6). The estimate is highly robust. We also examine the time-series response of available indicators of investment and entrepreneurial activity to changes in marginal rates. We find suggestive evidence of an impact on business formation, but no evidence of an important impact on other indicators.

Suggested Citation

Romer, Christina D. and Romer, David H., The Incentive Effects of Marginal Tax Rates: Evidence from the Interwar Era (February 2012). NBER Working Paper No. w17860, Available at SSRN: https://ssrn.com/abstract=2010392

Christina D. Romer (Contact Author)

University of California, Berkeley - Department of Economics ( email )

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David H. Romer

University of California, Berkeley - Department of Economics ( email )

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Berkeley, CA 94720-3880
United States
510-642-0822 (Phone)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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