Marginal Tax Rates and Income: New Time Series Evidence

81 Pages Posted: 29 Jun 2013

See all articles by Karel Mertens

Karel Mertens

Federal Reserve Banks - Federal Reserve Bank of Dallas

Jose Montiel Olea

New York University (NYU)

Multiple version iconThere are 2 versions of this paper

Date Written: June 2013

Abstract

Using new narrative measures of exogenous variation in marginal tax rates associated with postwar tax reforms in the US, this study estimates short run tax elasticities of reported income of around 1.2 based on time series from 1946 to 2012. Elasticities are larger in the top 1% of the income distribution but are also positive and statistically significant for other income groups. Previous time series studies of tax returns data have found little evidence for income responses to taxes outside the top of the income distribution. The different results in this study arise because of additional efforts to account for dynamics, expectations and especially the endogeneity of tax policy decisions. Marginal rate cuts lead to increases in real GDP and declines in unemployment. This study also presents evidence that the responses are to marginal tax rates rather than average tax rates. Counterfactual tax cuts targeting the top 1% alone have short-run positive effects on economic activity and incomes outside of the top 1%, but increase inequality in pre-tax incomes. Cuts for taxpayers outside of the top 1% also lead to increases in incomes and economic activity, but with a longer delay.

Suggested Citation

Mertens, Karel and Montiel Olea, Jose, Marginal Tax Rates and Income: New Time Series Evidence (June 2013). NBER Working Paper No. w19171, Available at SSRN: https://ssrn.com/abstract=2287031

Karel Mertens (Contact Author)

Federal Reserve Banks - Federal Reserve Bank of Dallas ( email )

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Jose Montiel Olea

New York University (NYU) ( email )

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