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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.

Suggested Citation

  • Christina D. Romer & David H. Romer, 2012. "The Incentive Effects of Marginal Tax Rates: Evidence from the Interwar Era," NBER Working Papers 17860, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:17860
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    References listed on IDEAS

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    Cited by:

    1. Kazuki Onji & John P. Tang, 2015. "A nation without a corporate income tax: Evidence from nineteenth century Japan," Discussion Papers in Economics and Business 15-12, Osaka University, Graduate School of Economics and Osaka School of International Public Policy (OSIPP).
    2. Karel Mertens & José L. Montiel Olea, 2013. "Marginal Tax Rates and Income: New Time Series Evidence," NBER Working Papers 19171, National Bureau of Economic Research, Inc.
    3. Laura Kawano & Joel Slemrod, 2016. "How do corporate tax bases change when corporate tax rates change? With implications for the tax rate elasticity of corporate tax revenues," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 23(3), pages 401-433, June.
    4. Riera-Crichton, Daniel & Vegh, Carlos A. & Vuletin, Guillermo, 2016. "Tax multipliers: Pitfalls in measurement and identification," Journal of Monetary Economics, Elsevier, vol. 79(C), pages 30-48.
    5. Francisco M. Gonzalez & Jean‐François Wen, 2015. "A Theory of Top Income Taxation and Social Insurance," Economic Journal, Royal Economic Society, vol. 125(587), pages 1474-1500, September.
    6. Robert A. Moffitt, 2012. "The Reveral of the Employment-Population Ratio in the 2000s: Facts and Explanations," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 43(2 (Fall)), pages 201-264.

    More about this item

    JEL classification:

    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
    • H24 - Public Economics - - Taxation, Subsidies, and Revenue - - - Personal Income and Other Nonbusiness Taxes and Subsidies
    • H31 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - Household
    • N42 - Economic History - - Government, War, Law, International Relations, and Regulation - - - U.S.; Canada: 1913-

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