Tax Cuts for Whom? Heterogeneous Effects of Income Tax Changes on Growth & Employment

Abstract

This paper investigates how tax changes for different income groups affect macroeconomic activity. Using historical tax return data from NBER’s TAXSIM, I construct a measure of who received (or who paid for) postwar tax changes for each income and payroll tax change that Romer & Romer (2010) classify as exogenous. At the national level, I aggregate tax changes for all taxpayers in the the bottom 90% and the top 10% of AGI and relate these aggregates to output, employment, and consumption growth. At the state level, I construct Bartik instruments for state tax shocks using national tax changes and each state’s share of high income taxpayers. If tax cuts for high income earners generate substantial economic activity, then states with a large share of high income taxpayers should grow faster following a tax cut for high income earners. I find that the negative relationship between tax changes and real GDP growth over a two year period is almost entirely driven by tax changes for lower income groups. The empirical relationship between tax cuts for the top 10% percent and job creation is negligible in magnitude, statistically insignificant, and much weaker than that of equivalently sized tax cuts for the bottom 90%.

Keywords: tax cuts, heterogenous agents, fiscal policy, paradox of thrift, business cycles

JEL Classification: E32, E62, H20, N12