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The Incentive Effects of Marginal Tax Rates: Evidence from the Interwar Era

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  • Christina D. Romer
  • David H. Romer

Abstract

This paper uses the interwar period in the United States as a laboratory for investigating the incentive effects of changes in marginal income tax rates. Marginal rates changed frequently and drastically in the 1920s and 1930s, and the changes varied greatly across income groups at the top of the income distribution. We examine the effect of these changes on taxable income using time-series/cross-section analysis of data on income and taxes by small slices of the income distribution. We find that the elasticity of taxable income to changes in the log after-tax share (one minus the marginal rate) is positive but small (approximately 0.2) and precisely estimated (a t-statistic over 6). The estimate is highly robust. We also examine the time-series response of available indicators of investment and entrepreneurial activity to changes in marginal rates. We find suggestive evidence of an impact on business formation, but no evidence of an important impact on other indicators.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 17860.

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Date of creation: Feb 2012
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Publication status: published as “The Incentive Effects of Marginal Tax Rates: Evidence from the Interwar Era” (with David H. Romer), American Economic Journal: Economic Policy, forthcoming.
Handle: RePEc:nbr:nberwo:17860

Note: DAE EFG ME PE
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  1. Martin Feldstein, 1993. "The Effect of Marginal Tax Rates on Taxable Income: A Panel Study of the1986 Tax Reform Act," NBER Working Papers 4496, National Bureau of Economic Research, Inc.
  2. Jon Gruber & Emmanuel Saez, 2000. "The Elasticity of Taxable Income: Evidence and Implications," NBER Working Papers 7512, National Bureau of Economic Research, Inc.
  3. Robert J. Barro & Chaipat Sahasakul, 1983. "Measuring the Average Marginal Tax Rate from the Individual Income Tax," University of Chicago - George G. Stigler Center for Study of Economy and State 26, Chicago - Center for Study of Economy and State.
  4. Smiley, Gene & Keehn, Richard H., 1995. "Federal Personal Income Tax Policy in the 1920s," The Journal of Economic History, Cambridge University Press, vol. 55(02), pages 285-303, June.
  5. Kopczuk, Wojciech, 2005. "Tax bases, tax rates and the elasticity of reported income," Journal of Public Economics, Elsevier, vol. 89(11-12), pages 2093-2119, December.
  6. Feldstein, Martin, 1995. "Effect of Marginal Tax Rates on Taxable Income: A Panel Study of the 1986 Tax Reform Act," Scholarly Articles 2766676, Harvard University Department of Economics.
  7. Giertz, Seth, 2007. "The Elasticity of Taxable Income over the 1980s and 1990s," MPRA Paper 18313, University Library of Munich, Germany.
  8. Lindsey, Lawrence B., 1987. "Individual taxpayer response to tax cuts: 1982-1984 : With implications for the revenue maximizing tax rate," Journal of Public Economics, Elsevier, vol. 33(2), pages 173-206, July.
  9. Thomas Piketty & Emmanuel Saez, 2003. "Income Inequality In The United States, 1913-1998," The Quarterly Journal of Economics, MIT Press, vol. 118(1), pages 1-39, February.
  10. Austan Goolsbee, 2000. "What Happens When You Tax the Rich? Evidence from Executive Compensation," Journal of Political Economy, University of Chicago Press, vol. 108(2), pages 352-378, April.
  11. Robert J. Barro & Chaipat Sahasakul, 1983. "Measuring the Average Marginal Tax Rates from Social Security and the Individual Income Tax," University of Chicago - George G. Stigler Center for Study of Economy and State 29, Chicago - Center for Study of Economy and State.
  12. Robert E. Lipsey & Doris Preston, 1966. "Source Book of Statistics Relating to Construction," NBER Books, National Bureau of Economic Research, Inc, number lips66-1, June.
  13. Slemrod, Joel, 1998. "Methodological Issues in Measuring and Interpreting Taxable Income Elasticities," National Tax Journal, National Tax Association, vol. 51(n. 4), pages 773-88, December.
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Cited by:
  1. Karel Mertens, 2013. "Marginal Tax Rates and Income: New Time Series Evidence," NBER Working Papers 19171, National Bureau of Economic Research, Inc.
  2. repec:clg:wpaper:2014-32 is not listed on IDEAS
  3. Francisco M. Gonzalez & Jean-Francois Wen, 2013. "A Theory of Top Income Taxation and Social Insurance," Working Papers 1306, University of Waterloo, Department of Economics, revised Oct 2013.
  4. Daniel Riera-Crichton & Carlos A. Vegh & Guillermo Vuletin, 2012. "Tax Multipliers: Pitfalls in Measurement and Identification," NBER Working Papers 18497, National Bureau of Economic Research, Inc.

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