Working Paper: NBER ID: w17531
Authors: Martin S. Feldstein
Abstract: The Tax Reform Act of 1986 was a powerful pro-growth force for the American economy. Equally important, as we look back on it after 25 years, we also see that it taught us two important lessons. First, it showed that politicians with very different political philosophies on the right and on the left could agree on a major program of tax rate reduction and tax reform. Second, it showed that the amount of taxable income is very sensitive to marginal tax rates. \n \nMore specifically, the evidence based on the 1986 tax rate reductions shows that the response of taxpayers to reductions in marginal tax rates offsets a substantial portion of the revenue that would otherwise be lost. This implies that combining a broadening of the tax base that raises revenue equal to 10 percent of existing personal income tax revenue with a 10 percent across the board cut in all marginal tax rates would raise revenue equal to about four percent of existing tax revenue. With personal income tax revenue in 2011 of about $1 trillion, that four percent increase in net revenue would be $40 billion at the current level of taxable income or more than $500 billion over the next ten years.
Keywords: Tax Reform; Tax Rates; Tax Revenue
JEL Codes: H0; H2; H21; H3; H31
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Reduction in high marginal tax rates (H31) | Increase in taxable income (H24) |
| Reduction in high marginal tax rates (H31) | Shift from untaxed fringe benefits to taxable earnings (H29) |
| Reduction in tax deductibility for certain expenses (H20) | Decreased consumption in tax-favored areas (H29) |
| Overall increase in taxable income (H29) | Increase in tax revenue (H20) |
| Reduction in high marginal tax rates (H31) | Elasticity of taxable income with respect to net-of-tax share (H32) |