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The Effect of Marginal Tax Rates on Taxable Income: A Panel Study of the1986 Tax Reform Act

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  • Martin Feldstein

Abstract

This paper reports new estimates of the sensitivity of taxable income to changes in tax rates based on a comparison of the tax returns of the same individual taxpayers before and after the 1986 tax reform. This comparison is done by using a panel of more than 4000 individual tax returns created by the Treasury that matches tax returns for the same taxpayers in different years. The analysis emphasizes that the response of taxable income is much more general than the response of traditional measures of labor supply and is likely to be much more sensitive to tax rates. The evidence shows a substantial response of taxable income to changes in marginal tax rates. The differences-of-differences calculations imply an elasticity of taxable income with respect to the marginal net-of-tax rate that is at least one and could be substantially higher. There is a brief discussion and simulation analysis of the implications of these estimates for the likely impact of the 1993 tax rate increases on tax revenues. Even the lowest estimated elasticity implies that the tax rate changes enacted in 1993 will lead to little additional personal income tax revenue.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 4496.

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Date of creation: Oct 1993
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Publication status: published as Feldstein, Martin, 1995. "The Effect of Marginal Tax Rates on Taxable Income: A Panel Study of the 1986 Tax Reform Act," Journal of Political Economy, University of Chicago Press, vol. 103(3), pages 551-72, June.
Handle: RePEc:nbr:nberwo:4496

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  1. V. V. Chari & Lawrence J. Christiano & Patrick J. Kehoe, 1993. "Optimal Fiscal Policy in a Business Cycle Model," NBER Working Papers 4490, National Bureau of Economic Research, Inc.
  2. Rose, A.K. & Svensson, L.E.O., 1993. "European Exchange Rate Credibility Before the Fall," Papers, Stockholm - International Economic Studies 542, Stockholm - International Economic Studies.
  3. David K. Backus & Patrick J. Kehoe & Finn E. Kydland, 1993. "International Business Cycles: Theory and Evidence," Working Papers, New York University, Leonard N. Stern School of Business, Department of Economics 93-21, New York University, Leonard N. Stern School of Business, Department of Economics.
  4. Christopher D. Carroll & David N. Weil, 1993. "Saving and growth: a reinterpretation," Working Paper Series / Economic Activity Section, Board of Governors of the Federal Reserve System (U.S.) 140, Board of Governors of the Federal Reserve System (U.S.).
  5. Bordo, Michael D & Choudhri, Ehsan U & Schwartz, Anna J, 1995. "Could Stable Money Have Averted the Great Contraction?," Economic Inquiry, Western Economic Association International, Western Economic Association International, vol. 33(3), pages 484-505, July.
  6. Christina D. Romer & David H. Romer, 1993. "Credit Channel or Credit Actions? An Interpretation of the Postwar Transmission Mechanism," NBER Working Papers 4485, National Bureau of Economic Research, Inc.
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