New evidence on marginal tax rates and income

by on July 1, 2013 at 9:01 am in Data Source, Economics, Law | Permalink

There is a new paper (pdf) from Karel Mertens:

This paper estimates the dynamic effects of marginal tax rate changes on income reported on tax returns in the United States over the 1950-2010 period. After isolating exogenous variation in average marginal tax rates in structural vector autoregressions using a narrative identification approach, I find large positive effects in the top 1% of the income distribution. In contrast to earlier findings based on tax return data, I also find large effects in other income percentile brackets. A hypothetical tax reform cutting marginal rates only for the top 1% leads to sizeable increases in top 1\% incomes and has a positive effect on real GDP. There are also spillover effects to incomes outside of the top 1%, but top marginal rate cuts lead to greater inequality in pre-tax incomes.

Morgan Warstler July 1, 2013 at 9:16 am

Right now, RGDP Growth and Income Inequality taste great together. Fighting the current is dumb.

Much like healthcare, this will be easier to swallow when we stop trying to use wages as our favorite tool for delivering safety net:

http://www.morganwarstler.com/post/44789487956/guaranteed-income-choose-your-boss-the-market-based

Once we know everyone has their nut covered, and everyone is working, worrying about wages is silly.

Rich Berger July 1, 2013 at 10:38 am

To the envious, everything causes inequality. Waah!

asgdfhg July 1, 2013 at 11:28 am

And why is inequality measued by pre-tax income?

prior_approval July 1, 2013 at 10:45 am

A late 80s Doonesbury strip involving Donald Trump and Uncle Duke taking Trump’s yacht to the GOP convention in New Orleans -

Trump – ‘By showing up in the ‘Trump Princess,’ we can send America an important message about the last eight years!’

Uncle Duke – ‘Which message is that. sir?’

Trump – ‘Tax breaks for the rich work!’

Uncle Duke – ‘A good message, sir! A timely message!’

But then, that was only a satirical take on what has apparently become dogma in the succeeding generation, at least in certain circles.

Ad Nauseum July 1, 2013 at 12:34 pm

Really? A Doonesbury comic strip satirizing Republicans? I would’ve never guessed…..

Frederic Mari July 1, 2013 at 10:52 am

“A hypothetical tax reform cutting marginal rates only for the top 1% leads to sizeable increases in top 1% incomes and has a positive effect on real GDP”

Surely, i am failing to read properly? Cutting rates for the top 1% increases the top 1% income? Is that not tautological? Or does he mean that people work more in subsequent years and thus report a higher income?

In any case, “positive effect on RGDP”? My, why don’t you tell it to this Economy? It’s not been listening for the last 30 years…

Clogging on a Porch July 1, 2013 at 11:30 am

Cutting rates for the top 1% increases the top 1% income? Is that not tautological?

You haven’t met many tax professionals, have you?

Barry Soetoro July 3, 2013 at 10:01 am

Are you saying RGDP hasn’t grown in the last 30 years?

Michael July 1, 2013 at 11:03 am

I think this result is widely believed when the rate in question is 70-90 percent ( as it was during some of the time periods in this sample). The question is, does it still hold once that rate is in the 30′s? If he is including both then he better be doing robustness checks to make sure results aren’t being driven by the time periods when top marginal rates were 90.

Finch July 1, 2013 at 11:29 am

I can only think that people who doubt this effect either never had to make a decision that would affect their income (Do I stay at the consultancy or get a corporate job? Does this startup makes sense?), or else are at the very start of their careers, so their experience with taxes is limited and maybe they don’t think things through.

When you make decisions such as whether a spouse should drop out of the workforce when you have kids, if the spouse has a professional career taxes are likely the biggest line item you get to remove from your budget, exceeding childcare expenses. A huge benefit of stay-at-home spouses is that the family gets the spouse’s productivity pre-tax. This happens _way_ before you hit 1% incomes with today’s tax rates.

Rich Berger July 1, 2013 at 11:44 am

Jawohl! Also, changing tax rates may have no effect on the majority of taxpayers, but a significant effect at the margin as some tip from more work to less work (if rates go up) or the reverse if rates go down. Not to mention leaving or entering tax shelters as rates change.

kiwi dave July 1, 2013 at 11:44 am

I wouldn’t be surprised if there was some level of causative relationship between the lowering of MTRs between the late 1960s and the late 1980s, and the increasing participation of women in the workforce (obviously it’s far from the whole story). Higher MTRs would no doubt result, at the margin, in more women staying at home.

To a lot of people that’s a feature, not a bug. Not just social conservatives: communitarians like Amitai Etzioni advocate higher MTRs specifically so that it will change the work/leisure balance.

Finch July 1, 2013 at 11:52 am

This is a much more sophisticated point and would make an interesting research project.

I get nervous about side-effects when people propose stuff like this, though. I imagine trying to increase SAHMs by raising MTRs would drive down birth rates, for example. I’m generally for making it easier for families to do what they think is right for them.

Bill July 1, 2013 at 12:26 pm

Finch, Regarding spousal withdrawal from the workforce, tax effects, and not having to pay for childcare:

Back in my ninth grade algrebra class, I recall that if you subtract something from one side of the equation, you have to subtract it from the other. So, when the spouse is working, pays taxes, and pays for childcare, and then quits to do childcare herself, you can’t attribute the decision solely to taxes: she is also not buying childcare and not paying for childcare.

But, at least she had a job.

Some people do not even have that. Of if they do, have no childcare.

kiwi dave July 1, 2013 at 12:32 pm

Agree, particularly with the last part. Interestingly, from my (unscientific) perspective, it seems that countries that have strong societal pressure on mothers not to work have the lowest birth rates (see e.g., Germany, a number of southern European countries, Japan) compared to countries with less such pressure (e.g. France, USA/Canada, Scandinavia).

Finch July 1, 2013 at 12:46 pm

Bill, I’m not sure I understand your reply. My point was that at middle-class incomes, working, particularly if you have a working spouse, is not nearly as attractive as your top-line salary number would make you think, mostly because of taxes. If it hadn’t been for taxes (and in particular high marginal rates on the second income), I expect my spouse would still be working, or at least would have worked several years more than she did.

I accept that people don’t go around thinking about marginal taxes from day to day, but when making life decisions it’s a huge factor.

Kiwi dave, I’ve noticed the same thing. The option of working, even if it’s not exercised, seems pretty valuable.

Bill July 1, 2013 at 12:55 pm

Finch, My spouse didn’t work either for a time and I have and had high income as well. I think you can understand my point: you can’t attribute it all to taxes: 1) you don’t have to pay for childcare (please admit); 2) your wife gets some leisure (please admit); 3) you get a happier household and your wife can do some things that you would have to do in your free time (please admit).

You can’t ignore the gains, or the reduced other costs (ie, no payment for childcare) and attribute the switch solely to a marginal tax rate.

I know that when my wife and I made this decision, and she was tired as hell working and also taking care of a newborn, the last thing she was thinking about was marginal tax rates. And, she usually gets her way.

Finch July 1, 2013 at 1:01 pm

Okay, now I understand. Taxes are not the only factor, for sure. They are just the largest factor, and without them (and at some lesser marginal rate) we would have made a different decision. That’s all I meant.

Finch July 1, 2013 at 1:09 pm

And for what it’s worth, we do strongly prefer this arrangement, though I was very skeptical of the idea at the time. Believe it or not, she helped talk me into it. But I think I thought that because I never really got a fair description of the alternative to a working spouse. I had this impression her brain would shut off and she’d stop being the girl I liked. I was naive. It is much better this way. We are both happier.

I’m pretty sure the tax code wasn’t designed with this in mind, however.

Cliff July 1, 2013 at 12:35 pm

We should be doing the exact opposite and making all childcare a tax credit. Not only would this greatly increase tax revenue, it would make GDP skyrocket as high-skilled professional women stayed at work, increase childbearing and therefore the productive population, just when we need it most with faltering demographics, and increase the social and emotional welfare of children (studies show kids in daycare are better socialized) and of mothers (most enjoy working).

Bill July 1, 2013 at 12:48 pm

Re tax credit: what if you have low income…how does a tax credit work for that. Tax credits work for the middle and upper middle class. You could just have a “credit” to equialize, rather than a tax credit.

kiwi dave July 1, 2013 at 12:53 pm

I disagree — I don’t think the state should be putting a thumb on either side of the scales.

Finch July 1, 2013 at 1:00 pm

This is just a difficult problem to solve with progressive taxes.

While I agree with kiwi dave and I’m uncomfortable trying to manipulate people in general, Cliff’s idea has some merit. The thumb is already on the side of not-working. Taxes are structured so as to provide a huge disincentive for spouses to work if they earn middle-class incomes. Child care expenses are sort of like a business expense: they’re a cost necessary to earn money. If the spouse was a firm, they’d deduct the expense to get net income and pay taxes on the result.

Having it be a refundable credit would be a disaster. Talk about perverse incentives.

Cliff July 1, 2013 at 1:00 pm

Bill,

We should only be encouraging people to work when the product of their work is greater than the product of their staying home. It seems a tax credit reasonably accomplishes that objective.

Kiwi dave,

It’s really an issue of consistency in the tax code more than anything else. Business expenses are deductible, consumption is not. Childcare is a business expense, that’s it.

Andrew' July 1, 2013 at 1:53 pm

Here’s how it works: work harder.

Bill July 1, 2013 at 7:27 pm

Cliff, you didn’t address the tax equity point. It would seem, furthermore, that you are discouraging the poor more than the rich with a tax credit proposal.

mark July 2, 2013 at 10:42 am

Marginal income tax rates for the top 1% are well over 50% in nearly every state. You can’t just look at the federal income tax rate. There are also Medicare taxes and state and local income taxes, etc. There are other taxes as well (and other ways income taxes are driven upwards other than rate, such as through the limitation on deductions but as this thread is just about marginal income tax rates I will leave them out for now).

Barry Soetoro July 3, 2013 at 10:04 am

Yeah, people are too stupid to realize this. My marginal rate is over 43% and I don’t even make 90k.

x July 1, 2013 at 11:41 am
Bill July 1, 2013 at 12:35 pm

Thanks.

1. He excludes capital gains income (p2).

2. On page 2 he says of a broader tax reduction for lower incomes (rather than higher): “These values [for income tax cuts for the top 1%] are less than half those for a
tax reform cutting marginal rates more broadly… p.2

AD July 1, 2013 at 4:34 pm

“After isolating exogenous variation in average marginal tax rates in structural vector autoregressions using a narrative identification approach”

Uhhh… What? I’m guessing there wasn’t a chapter on this method in Mostly Harmless Econometrics.

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