Working Paper: NBER ID: w19171
Authors: Karel Mertens; Jos L. Montiel Olea
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.
Keywords: marginal tax rates; income elasticity; tax policy; economic activity; inequality
JEL Codes: E6; E62; H2; H24
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| counterfactual tax cuts targeting the top 1% (H31) | positive effects on economic activity and incomes for other income groups (F62) |
| counterfactual tax cuts targeting the top 1% (H31) | increase inequality in pretax incomes (D31) |
| cuts for taxpayers outside of the top 1% (H29) | increases in incomes (D31) |
| cuts for taxpayers outside of the top 1% (H29) | increases in economic activity (E20) |
| marginal tax rate cuts (H31) | increases in real GDP (E20) |
| marginal tax rate cuts (H31) | declines in unemployment (J64) |
| lower marginal tax rates (H29) | higher reported incomes (E25) |
| higher reported incomes (E25) | stimulates economic activity (E20) |